What is the "long-term mean" of real estate as a % of GDP?

June 12, 2009 in Economics

Felix Salmon's chart of the day comes by way of wcw and shows household assets as a percentage of GDP:

Felix notes:

If this line reverts to the long-term mean, the extra evaporation of housing equity would be utterly devastating. But is there any reason to believe that it won’t?

But I wonder, what is the long-term mean of this statistic?

On the one hand, there is the regime that prevailed for almost the first 30 years, where real estate comprised a bit more than 80% of GDP. Returning to those levels would indeed be devastating in the near term.

On the other hand, there is the actual average of the values exhibited since 1950, which is closer to 110%. Still worrisome, but not as bad.

Finally, we must consider the real possibility that the steady state of this number has naturally inflated with time. As banks offered higher LTV's, it became easier for Americans to invest the same part of their income in more valuable homes. This suggests that home values as a % of GDP could reasonably be increasing. Additionally, more developed capital markets have made it easier to unlock that value (and measure it), furthering the relative growth of home values.

If you naively detrend the graph, we are near to or potentially even below the mean value. However, a simple detrend would be insufficient because the reason I've outlined would not allow unlimited growth; they would merely account for a rise in growth since 1950. It may not be appropriate to extrapolate similar growth for the future.

Moreover, even if we had crossed a time-sensitive mean, the sharpness of the decline makes it highly likely that we will overshoot the mean rather than simply return to it. That over-correction will be painful no matter what the mean-reverting level is.

Finally, it's also interesting to note that GDP has increased because of house values rising - homeowners have been able to extract increasingly large portions of their home equity and transform that into  consumption. In the last decade in particular, a large part of consumption has been driven by this mechanism. Thus, the denominator of the graph is growing as well, meaning the growth in real estate assets is even more dramatic than one might otherwise think!

So, what do you think is the "normal" level of real estate as a percentage of GDP? I'd write "long-term mean" but as you can see, I'm not convinced that the mean is stable over the long term at all.

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