This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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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.

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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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This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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We wrote back in June of 2008: “The Holy Grail de jour of financial market prognostication is predicting the bottom in housing. It’s a fool’s errand, however.”

Identifying the low point in any asset class is an effort best left for speculators and academics. The former must be willing to be wrong and lose big, the latter can play Monday Morning Quarterback and look back in time to identify turning points that happened months, if not years in the past.

With all that said, it’s still helpful to look at how far home prices have fallen since their peak in 2007. As can be seen below, we are now back to prices as they stood in 2004, during the height of the boom. This is hardly comforting.

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Statistics being what they are, however, it also depends on how you keep score. The Case-Shiller Home Price Index, a widely quoted metric that compares paired sales (which measures the change in sales of individual homes over time), places us closer to 2003 values. Some individual markets look a bit better, others far worse.

Another interesting item to note is the lag between the peak in year-over-year home price appreciation and a peak in prices. Looking below, we see that it took almost 3-years for the high of 14.3% y/y appreciation to be matched with a high median price of $248,467. Even the nominal peaks (ignoring moving averages) are 20 months apart, meaning year-over-year data can be viewed as a leading indicator for nominal prices.

Heading in the other direction, there is a similar lag between the most precipitous fall in prices and the actual bottom in prices. Comparing what we see below to the chart on the next page foretells patience before hailing the all-clear: A mere 6-months have passed since what many believe to be the nadir of home price declines.

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This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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Given the widespread expectation for future inflation, and as an extension higher interest rates to combat rising prices, the question above is the most common one we hear from home buyers and real estate investors alike. To try and resolve the issue to completion on this short page would be ambitious, to say the least.

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During the inflationary period of the late seventies and early eighties (flip back to pg 5 for a picture of
inflation during this period), mortgage rates climbed to almost 20%. In a world where locking in a rate north of 5% feels like a rip-off, 20% mortgages are a thing of fantasy.

Yet, despite this seemingly gale force headwind, home prices still climbed. While there are number of reasons for this increase (demographic, regulatory, etc), let’s focus on one in particular: Inflation Expectations.

Thumb through speeches written by pointy-headed Fed economists and you’ll find this phrase, “Inflation Expectations” peppered throughout discussions of monetary policy and the fear of rising prices. This is one of the least appreciated, yet most important aspects of effective use of monetary policy to manage inflation.

At the core, all economic decisions reflect participants’ view of the future. Specifically, buyers consider what utility (ie, use) they can receive and whether the price for that utility is fair. Embedded within this decision is some expectation of what can be done with that money in the future: Saved, spent, invested, etc.

When consumers fear rising prices, that a gallon of gas will cost more tomorrow than it does today, they buy the gas today. This pushes future demand forward, increasing aggregate demand and in turn, prices. The cycle continues, and in extreme cases (think Zimbabwe or the Weimar Republic), hyperinflation ensues.

As inflation rises, so too do Inflation Expectations. Consumers deploy capital towards assets they perceive to be a better store of value than the worthless paper in their pockets. They buy gold, they buy oil, they buy real estate. So, even with higher rates, money still flows into housing.

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US Median Home Price 1965-2009
Gray area is “Inflation” period of 1972-1983, 201% total increase in home prices during that 12 year period, or 10.5% annually.
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Consumer Price Index 1965-2009
Gray area is “Inflation” period of 1972-1983, 147% total increase in CPI during that 12 year period, or 8.5% annually.
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CPI vs. Median Home Price 1972-1983
Close up of the gray area, home prices seemed to outpace inflation a bit during the peak inflation late ’70s early ’80s.
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CPI vs. Median Home Price (y/y change) 1972-1987
Extended the view a bit, on the way up Home Price change peaked before CPI (’72) and bottomed first as well (’80, ’82). Home prices off to the races again in the mid-late ’80s.
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30-yr Fixed Mortgage rates vs. Median Home Price 1972-1987
Home price gains slowed as rates ramped, but even with 18% rates annual home price change only briefly declined.
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30-yr Fixed Mortgage Rates vs. Median Home Price 1972-1987
As shown above, high rates slowed down increases but declines did not last long and prices started going up again when they lowered rates.
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