Dec292016

House prices may never reach the inflation-adjusted peak from 2006

House prices exceeded the 2006 housing bubble peak in 2016, but when adjusted for inflation, house prices may never reach that benchmark.

The NASDAQ recently surpassed the tech bubble high from 2000. Anyone who bought the index in March of 2000 could finally sell their holdings without losing money. While some investors cheer this victory, those investors who didn’t take a loss received dollars back from the trade that retained significantly less buying power than they held in 2000. In fact, after adjusting for the erosion of buying power, these investors still lost a third or half of their money.

Investors in real estate make the same mistake. I recently demonstrated that an investor can sell a house for $100,000 profit and still lose money by ignoring carrying costs, transaction costs, and inflation. Many real estate industry watchers celebrated home price indices reaching their bubble-era peak this year. But like the stock investors from the tech bubble, it’s a hollow victory that fails to account for the ravages of inflation.

Many homeowners feel relieved their homes are now worth what they paid, but this illusory relief ignores the decreased buying power of their money tied up in the value of their house. On an inflation-adjusted basis, buyers during the bubble will never get back to breakeven unless there is another real estate bubble similar to the Great Housing Bubble.

 

Inflation-Adjusted Projections for Los Angeles, 1987-2012

 

The powers-that-be tried to inflate prices by lowering mortgage rates, and to some degree, it has been successful. However, with inflation right around the corner, the nominal gains may no longer translate to real gains.

PriceRentJan2015

The Real Story About Rising Home Prices

By STEVEN RUSSOLILLO, Dec. 26, 2016

Inflation-adjusted home values are far below their 2006 peak, and achieving a new high could be tough to achieve in the new year [or ever]

By one measure, the housing market’s lost decade is finally a thing of the past. In real terms, it is far from over.

I wonder if the editor made the reporter add the phrase “in the new year” when referring to when the market will reach an inflation-adjusted high. Realistically, it will be many, many years away — if it ever reaches that peak.

The powers-that-be used mortgage interest rate stimulus to get us this far, but that stimulus is played out. Mortgage rates will likely rise from here, so rising house prices absent inflation in the rest of the economy doesn’t seem likely. If wages begin rising more rapidly, nominal house prices may continue rising even in the face of rising mortgage rates, but general price inflation is likely to accompany rising wages, so inflation-adjusted gains in housing will prove elusive.

U.S. home values in September topped their previous peak from a decade ago, according to the S&P/Case-Shiller 20-City Home Price Index. New data expected Tuesday should show more of the same in October. Prices have grown at about a 5% annual clip for much of the past two years.

On paper, home-price increases may have come full circle following the worst housing bust since the Great Depression. But these nominal price gains don’t take into account the consumer price increases that inflate home values over time. In real terms, the index still is about 16% below the 2006 high. A number of factors could make further price appreciation and possibly even a new inflation-adjusted high that much tougher to come by in the new year.

I will make the not-so-bold prediction that house prices will not rise 16% on an inflation adjust basis in 2017, probably not by 2027 either.

The market is flashing warning signs. The homeownership rate still hovers near a five-decade low and it is tough for less-affluent buyers to obtain mortgages. Meanwhile, mortgage rates have risen substantially since Donald Trump’s election victory, which will affect affordability.

Even without that, historical trends suggest that housing prices aren’t likely to keep rising at their current pace. For instance, since prices bottomed in 2012, they have risen in real terms at more than 5% a year, according to data courtesy of Yale economist Robert Shiller.

Those inflation-adjust gains are entirely a byproduct of lowering mortgage rates from 6.5% to 3.5%.

That is great news for current homeowners but bad for anyone looking to buy, particularly first-time buyers. The appreciation far exceeds income growth over that time frame.

Since 2000, which captures the housing boom and boost, this inflation-adjusted annualized gain is 1.6%. Yet real home values have risen at only a 0.5% annualized rate since 1890.

Much of the price gains over the past four years represented home values recovering lost ground from the financial crisis. But the pace of gains in the years leading up to the bust was substantial, lifting the recent pace well beyond its normal trend.

At 0.5% per year, it will be a very long time before prices rise 16% — something like 32 years, perhaps a few less with compounding.

Owners waiting for those gains will need to be very, very patient.