Home Prices: A Much Needed Breather
January 4, 2010 in 2010 Predictions, Best Of The Storm, Data, Data, and More Data, Fresh Perspectives
This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux
Life is always so much clearer in hindsight.
The graph below shows the US Median Home Price (blue line, as measured by the 6-month moving average of the Median Price, admittedly as arbitrary a metric as any other) graphed against the year-over-year change in prices (red line). While it doesn’t take a degree in econometrics to identify the ongoing correction as the most significant in recent memory, here are a few additional items to glean from this broad view of history.
First, on a year-over-year basis, even at the height of the real estate boom in 2004, at no point did prices rise as quickly as they did in both of the booms in the early 1970s or mid-late 1980s. Instead, prices grinded upward without a meaningful correction: Prior to late 2007, the last annual decline occurred back in 1992.
Second, although prices are now roughly back in line with the historical trend of appreciation, understanding what drives this particular dataset paints a somewhat cloudier picture. Of the myriad ways to measure home prices, Median Price, despite being the most ubiquitous, can be misleading. Foreclosures and other distressed sales have driven the most active housing markets in recent years, so a larger-than-normal portion of sales have occurred in lower priced markets. This, in addition to nominal price declines, has skewed median price data to the downside. Now, as lower-priced markets stabilize and luxury markets continue to tumble, the dataset should return to a more historic mix of cheap as well as expensive homes. This means median price data could show appreciation where, in reality, no such rise in prices exists.
Finally, it is crucial to understand home prices in relation to inflation and the value of the dollar. Continue reading for some interesting comparisons between home prices and inflation while considering this: Simply adjusting for inflation and ignoring all other factors, a house bought in 1965 for the median price of $17,200 would cost $118,123 in today’s dollars. With the current median price just over $200,000, that means more than half of all home price appreciation in the past 45 years can be attributed to inflation. Nothing more, nothing less.
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Andrew,
Good analysis. Just wanted to comment on the inflation portion. If inflation has only contributed half of the gain in home prices, then I would suspect that prices have much further to fall.
Despite what most people believe, homes are not an investment. They are a manufactured good. They are just like cars in that they are needed for a purpose: in this case, a place to live. So the prices of homes should be tied directly to either inflation (as cars typically are) or wage growth.
During the 80s and 90s wage growth exceeded inflation due to the initial benefit of outsourcing. We got lower priced products from China and other emerging economies that kept prices in check. And, incomes actually rose as we still maintained a strong manufacturing economy and growing service sector. This meant home prices should grow faster than inflation.
However, wages have grown slower than inflation this decade. This trend will certainly continue as our economy has not been altered permanently from the outsourcing phenomenon of the 80s and 90s. Today, many of the manufacturing jobs are gone for good. As China’s and other emerging countries experience a rising standard of living, ours will shrink. This is an effect of the outsourcing trend.
The service sector will not grow as fast as it did in the 80s and 90s because we now have overcapacity in this area. There will still be some growth, but no where near the previous growth due to lower wages in the US and overcapacity.
This means that homes will track inflation, and may even come back to the inflation adjusted prices.
Some may argue that the average home price is higher because the average home is now larger with more modern features. This is true and will account for a bit of a higher average price. However, the cost of those inputs has dropped due to outsourcing so this effect alone does not justify a large price increase relative to the past.
Home prices might climb fast if inflation gets out of control. But, that is only good for current homeowners. It will devastate the new home market, especially if wages don’t keep up with inflation, which I suspect is the case.
Hi Kirk,
All very good points, it’s impossible to get a complete picture of inflation (or home prices for that matter) without looking at wages … and a whole host of other issues.
One difference I would point out between houses and many other manufactured goods is their ability to generate income. While most homeowners don’t look at houses this way, real estate investors certainly do. So in some respect, the value of homes can be looked at from an income generating perspective.
In fact, from most of the data I have seen, tracking rent vs. buy ratios proved to be a far better gauge of markets stabilizing than price vs. income ratios. Prices slid right through historical metrics on price vs. income and investors only stepped in when it started making sense to buy and rent.
This concept is more or less applicable in certain markets, to be sure, but it is one way homes differ from cars or other manufactured goods.
Appreciate the thoughts!
Andrew