Home prices rise for first time since ’06

Home prices from April to May rose 0.5% according to the Case-Shiller Index. This index tracks home prices in 20 markets considered to give a good cross-section of home prices. While not an amazing increase, it was the first time since July 2006 that the prices increased.

Needless to say this is a good sign. It means that supply and demand are finally equilibrating in the housing market. Consequently prices are starting to rise. Let’s keep our fingers crossed that this continues. Why? Because lenders will be more willing to lend money if home prices stabilize in rise. That will un-freeze the credit markets and get lending moving again.

While I generally do not like consumer debt, I do consider it to be essential for two purchases: homes and cars. The reason is that without debt, people would have to save money for 30 years to be able to afford a home. Meanwhile, they forgo living more comfortably and an investment in an asset that generally appreciates in value. Cars improve the productivity of most people because most cities don’t have public transportation that is more convenient than hopping in your car to get to work or run errands.

Now credit for businesses is a totally different story. Companies use debt to finance new projects that hopefully lead to more growth. As an owner (i.e. a shareholder) in a business you want the business to use the cheapest capital it can to finance its growth. That typically is debt. The cost of debt is usually about 7-8% cheaper than equity. Why? Because debt holders are higher up in the capital structure and because companies can deduct debt interest payments from their taxable income. Being higher in the capital structure means that in the event of dissolution of the company, debt holders have a higher claim to assets than shareholders. This lowers the risk to debt holders so they demand less of a return. The second benefit, the tax one, also lowers the cost of debt to the business. However, debt does have a burden. Namely, you have to pay interest regardless of business conditions. Ugh! What that means is that projects/new growth ideas that are believed to be able to generate stable cash flows are ideal projects for debt financing. Those will unstable cash flows and a payoff that is 5+ years into the future are better financed with equity. Does this all make sense?

Anyway, home prices were up in May. I am pretty sure that they will be up in June, too. Hopefully some momentum can get going.

Have a wonderful day!

Jason