Inflation Adjusted Real Estate Prices- Lets take a look at the idea that housing prices always go up. Of course, each neighborhood is different, so some neighborhoods might be going down while a few miles away housing prices are skyrocketing but by looking at the nationwide average and by adjusting those prices for inflation we can get a better picture of how real estate prices really act…
For many years people believed that “housing prices always go up” and that “you can’t go wrong buying a house” and that “houses are good investments”. These core beliefs were shaken from 2008-2012 and many people became disillusioned and decided that houses weren’t worth the hassle.
But are houses really good investments? What makes people believe that a commodity that you consume is actually an investment? Doesn’t it require maintenance? Shouldn’t a new house be worth more than an old one?
One fundamental philosophy that Robert T. Kiyosaki stresses in his book Rich Dad Poor Dad: What The Rich Teach Their Kids About Money – That The Poor And Middle Class Do Not! is that a house is not an investment unless it is actively producing revenue i.e. being rented out. The key is to understand the difference between an investment and a consumption item. One of his favorite sayings is that The Wealthy Buy Assets, the Poor Buy Liabilities, and the Middle Class Buy Liabilities Believing They Are Assets.
[Editor’s Note: Although Kiyosaki may technically be correct traditionally homeownership may be the only savings program many Americans have. See “forced savings” below.]
Advantages of Buying a House:
- A house is like a forced savings plan for people who normally aren’t in the habit of saving or investing.
- It uses “leverage” i.e. other people’s money to get more than you could afford by yourself so when home prices do go up you benefit much more. House leverage is much greater than it used to be with Government programs allowing you to borrow 95% of the value of the house. So if you put 5% down and the house goes up 5% you have doubled your money. Where if you had to put 100% down you would have only made 5%.
- You can build “sweat equity” by improving the house through your own labor (untaxed).
- Since you are paying it off over time you are using “cheaper dollars” due to inflation to pay off the mortgage.
- Houses are real assets (not paper) so their value tends to keep up with inflation.
Disadvantages of Buying a House:
- Incidental costs can add up- Taxes, Insurance, Maintenance, HOA fees, etc.
- Leverage can work against you when house prices go down as they did in 2008 the devastation is much worse than if you owned the house outright.
- In times of deflation, you are paying your mortgage with “more expensive dollars” and the value of your house in dollars may be going down.
- Houses are not “liquid” it may take time to sell if you need to move.
- You lose a significant chunk of value (10-20%) when you sell due to transaction costs i.e. Real Estate agent commissions, inspections, government agency fees etc.
Inflation-Adjusted Real Estate Prices
Let’s take a look at the idea that housing prices always go up. Of course, each neighborhood is different, so some neighborhoods might be going down while a few miles away housing prices are skyrocketing but by looking at the nationwide average we can get a better picture of the overall trend. The St. Louis Federal Reserve publishes the following chart that shows the S&P/Case Shiller National Home Price Index and I’ve added a red arrow indicating that generally prices do rise but there have been times (especially during recessions i.e. shaded areas when prices have been flat or even moved down. But if we look a bit closer we will see for most of the 1990’s house prices were basically flat even though only a small portion of that time was classified as “recession”. Note that the blue line crosses the 100 mark at exactly the year 2000. This is by design as the index was set for January 2000 = 100.
And these prices are in “nominal” dollars meaning that the value of each of these dollars was depreciating due to inflation. So what happens if we take inflation into account? In the following chart, I’ve extracted the data from the above chart and adjusted it for inflation. Once again you can see that the blue line crosses the 100 mark in the year 2000. But the orange line shows the effects of inflation i.e. if the value of the dollar was the same in 1975 (and every year in between) as it is now.
From this chart, we can see that if you had bought a house at the peak in 1980 you would have lost purchasing power if you had sold in 1985 (not to mention transaction costs). And then for a little while around 1990 you would have been slightly ahead, but then through most of the 1990’s you would actually be losing money once again. So you’ve paid off half of your 30-year mortgage, you’ve paid taxes, insurance, maintenance, etc. and your house has not kept up with inflation! Then something crazy happens, housing prices skyrocket in an unprecedented manner not only in nominal terms but even in inflation-adjusted terms. Looking back we can see that this was a classic bubble but at the time everyone was euphoric and believed that housing prices only went up (forgetting that just 10 years before that was not the case.) This is one major disadvantage of inflation it masks the real facts and makes everything look rosier. People were only looking at the chart above. Very few people were looking at the inflation-adjusted numbers.
So How Could a Bubble Like This Happen?
This was primarily the result of government policy changes not due to any intrinsic value in houses. What happened was that congress (primarily Democrats) decided that everyone has the “right” to buy a house whether they can afford one or not. So in order to facilitate this utopia, they instituted loose lending practices through Governmental Fannie Mae and Freddie Mac agencies. And at first it had wonderful effects on the economy demand for houses rose builders made money, banks made money, life was good.
This combined with a loose money policy by the FED to goose the economy through the turn of the century Y2K scare and then the FED added in artificially low-interest rates and you have a government-sponsored housing bubble. But to make matters worse some smart guys on Wall Street figured out how to squeeze even bigger bucks out of this boom by using some creative financing and slicing and dicing these mortgages (which everyone now thought could only go up). Since they believed that most people wouldn’t default on their mortgages, if you bundle enough of them together the risk was very low. So with low risk you could use extreme amounts of leverage to buy these mortgage derivatives and theoretically make a fortune.
But remember the foundation was that anyone could get a mortgage even if they couldn’t afford it. So when housing prices stopped going up in 2006 and people realized that inflation wasn’t going to bail them out, they began defaulting on their mortgages this snowballed and took down these large derivative bundles of mortgages and because they were highly leveraged in themselves when the tide turned against them it took down some of the biggest players on Wall Street like Bear Stearns and Lehman Brothers.
The Aftermath of the Housing Bubble
From the peak in 2006 to the bottom in 2012, inflation-adjusted housing prices lost 35.3% nationwide with some areas like Florida and Nevada losing 50% or more. Since 2012 prices have begun rebounding and in nominal terms prices are slightly above the level they were in 2006 (blue dotted arrow). Although. there are many pockets around the country that have still not reached 2006 levels. But to make matters worse if you look at the inflation-adjusted housing prices (orange dotted arrow) you’ll see that prices still have a long way to go to reach 2006 levels. So when you look at the real underlying value not just the nominal price you will see that not only don’t prices “always go up” but they can easily be lower a decade or more later.
You might also like:
- Inflation-Adjusted Gasoline Prices
- Inflation-Adjusted Oil Price
- Effects of Inflation on Businesses
- Real Estate Trends: House Flipping
- Gold and Inflation
- Food Prices 1913 vs. 2013
Recommended by Amazon:
-
The Big Short: Inside the Doomsday Machine – Best Seller by Michael Lewis about what really happened in 2008. One reader put it this way, “In “The Big Short,” Michael Lewis tells the story of the subprime mortgage crisis in a way that couldn’t be more removed from my own perspective, or that of anyone I knew: the story of the money managers, traders, and analysts who figured out the weaknesses in the subprime bond market and placed their bets that the bubble would burst in a *big* way, and *soon*. They were right, of course, but even they didn’t realize just how deeply corrupt the system was, or how devastating the fallout would be when the crash came.”
- Real Estate Investing Gone Bad: 21 true stories of what NOT to do when investing in real estate and flipping houses– Discover 21 true stories of real estate investing deals that went terribly wrong and the lessons you can learn from them. The cost of these “deals gone bad” total millions of dollars in losses, years of unproductive activity and incalculable emotional stress. However, you’ll obtain the enormous benefits of the powerful and profitable learning lessons from these 21 mishaps without the costs! You’re about to gather lifelong, extremely valuable real estate investment and house flipping wisdom that has taken others a lifetime and a fortune to learn. This book is a must read for anyone planning to be or is already a real estate investor because you’ll find out what NOT to do in real estate.
- Anatomy of a Financial Crisis: A Real Estate Bubble, Runaway Credit Markets, and Regulatory Failure– An in-depth look at the origins and development of the current financial crisis, from an economist and Washington insider. Jarsulic explains how a wide array of financial institutions, including mortgage banks, commercial banks, and investment banks created a credit bubble that supported nonprime mortgage lending and helped to inflate house prices.
- The Great American Land Bubble: The Amazing Story of Land-Grabbing, Speculations– 2011 Reprint of 1932 Edition. Full facsimile of the original edition, not reproduced with Optical Recognition Software. Originally published in 1932, Sakolski’s book is the first general history of land speculation in the American colonies and the United States. It begins with the Pre-Revolutionary War Ohio Companies, and thereafter its chapters cover most of the land booms and bubbles up to the twentieth century. Two hundred years of get-rich quick schemes give the reader a concentrated exposure to the gamble and promoting aspect of the American character.
- Masters of Nothing: How the Crash Will Happen Again Unless We Understand Human Nature– “Many books about the crash have observed that too many risks were
taken with other people’s money; this is the best explanation I’ve read of just what it was that possessed the risk-takers.”
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amazing data. thank you Tim Mac
Good discussion! Awaiting a reply from Mr. McMahon to Mr. Landman, including the current state of market regulation.
I do have a question: what will be the effect on the price bubble when interest rates go up for housing loans on home values?
Do we see a home purchasing surge to beat out higher interest rates & secure a home away from city centers (where the workforce numbers are in decline) in order to capture inflationary effects with an asset? I assume rents will be going up as inflation goes up. . .
Generally higher interest rates put a lid on housing prices because the price you actually pay includes interest. After-all you can only afford what you can afford and that includes interest, taxes, insurance, maintenance, etc. If the interest portion goes up the amount you can allocate toward principal (i.e. the actual cost of the house) must go down. As far as a surge, maybe, but people don’t generally move quickly when it comes to housing. Those who are currently in the market anyway may be more willing to jump a bit quicker but I think that is about it.
Run Away from this Guy – Tim McMahon.
He is lying about one of these two things.
1. He says his grand father suffered from hyperinflation in Germany.
2. He is republican. (Republicans are directly responsible for creating inflation (helicopter money, rolling back New deal protections, etc….) so if you or your loved one suffered from inflation you can not be republican. Unless you are charlatan.
Ha Ha Good one. You don’t even use your real name or email but I’m the Charlatan? In response to your comment. 1) How do you know I’m a Republican? I’ve never said one way or the other. 2) Traditionally, Democrats have been in favor of “Tax and Spend” the primary driver of Inflation. And all the “helicopter money” in QE1, QE2 and QE3 came under a Democrat administration. 3) Traditionally Republicans have been the party of fiscal responsibility i.e. the antithesis of Inflation. I will admit that in recent years Republicans have fallen into the spending trap as well.
I am so sorry, but its obvious you are a republican the way you defend the party. Today the republican part is not as prestigious as it used to be. Today its a bunch of facists and racists who want to make “America great again” with the help of Q. It has become a cult and the younger generations will not allow America to go down this kind of path. I know this angers you Tim, and its alright to feel that anger.
Jone Doe is that you again under a different pseudonym?
And here I thought Democrats were so tolerance and valued diversity. How about those microaggressions and safe places. Sad to see all the hate especially to someone who is simply reporting facts. I wish Democrats would look into the mirror more to see the ugliness they spread, while at the same time preaching, preaching, and more preaching.
John Doe you make no sense. Save your remarks for yourself as that was a stupid response.
Am conducting research on US housing prices, mortgage rate, and the unemployment rate. Thanks for the great insight.
You left out 3 of the biggest advantages of owning a home:
1: You get to live in it rent free.
2: Mortgage interest is tax deductible.
3: Profits when you sell are tax free.
My own experience: 1971: bought first house for $20K. 1977: Sold it for 37.5K, bought one for same price. 1986: Sold it for 55K, bought one for 80K. 2016: Sold it for 525K, bought one for 430K. If we’d been renting all that time we could never have built that wealth or afforded to live in the homes we’ve had because rental (except shortly after purchases) would have been more than the mortgage payments. We’re now retired & own F&C. Don’t tell ME home ownership’s not a good investment (yeah, every investment has its downturns).
I don’t see how your experience transfers to today.
House prices blew up astronomically, relative to inflation, during the period you described – it was a fantastic period to buy and hold a house.
As a first time buyer, the value for money presented to me in 2020, and the potential for long term appreciation of the asset seem very low.
I’m not confident it’s the right way to go here and now – certainly in 1971, in 2020 not so much.
Seems like you learned nothing from even just looking at the charts from the article… You started buying into housing when it was a significantly smaller portion of people yearly budgets and well before it started it’s 30 year climb into a bubble where its basically stayed since then. A median purchase in the 60’s and 70’s was an actual house; small but still 2-3 beds. Last year in Los Angeles, it would get you a 600sqft condo; and not a very nice one. Renting hasn’t gotten any easier either as rent prices generally tend to track housing prices, locally.
Houses weren t always this expensive. In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 indollars, according to data from the U.S. Census .
That is true but the median house in 1940 was also only about 800 sq. ft had one bathroom, no garage, no A/C, very little insulation, and a 60 Amp electrical service. There were also a lot of “cold water flats” i.e. didn’t even have hot running water. You could probably buy a similar home for less than half the price of a modern median-priced home if you wanted one.
I appreciate the inflation adjusted graph. It’s nice to see the bubble we’re currently in is not as bad as last time. However I strongly disagree with your historical assessment of why the bubble formed. Housing affordability for lower income families was always a goal under both parties’ leadership. Indeed Fannie and Freddie low income loans performed better than overall mix during the 2008 and forward period; and incidentally during the collapse FHA loans went from being 1/200 mortgage originations to a large part of the market and they were loaning up to $700k per home. What a large driver in the 2004-6 run up was speculation and overlevering at the RE investor level then a large pullback in investor demand for RE in 2007. The banks were not being controlled by government policy; they were responding to large global pools of capital coming from petrostates and emerging markets looking for safe high yielding investments so they lowered lending standards to produce that product and pressured ratings agencies to overvalue their securities. Once those lending standards went down the mom and pop RE investors over leveraged by lying about living in the homes they were purchasing so they could get a cheaper mortgage and have a better spread when renting. Those folks pulled out hard in 2007 and dropped originations by 1M that year; that was the first domino.
Excellent point thank you. However, several Republican Senators/Congressmen recognized the bubble in the making and tried to propose legislation to reign in the excesses in the 5 years prior to the crash and they were laughed at and overruled by the Democrat majority.
What do you mean by “Democratic majority”? https://www.infoplease.com/us/government/legislative-branch/composition-of-congress-by-political-party-1855-2017
Do explain.
“Mythmaking is in full swing as the Bush administration prepares to leave town. Among the more prominent is the assertion that the housing meltdown resulted from unbridled capitalism under a president opposed to all regulation. Like most myths, this is entertaining but fictional. In reality, Fannie Mae and Freddie Mac were among the principal culprits of the housing crisis, and Mr. Bush wanted to rein them in before things got out of hand. Rather than a failure of capitalism, the housing meltdown shows what’s likely to happen when government grants special privileges to favored private entities that facilitate bad actors and lousy practices.” https://www.rove.com/article/president-bush-tried-to-rein-in-fan-and-fred-16021
Wait, you’re trusting Karl “Is this just math you do as a Republican to make yourself feel better?” Rove?
(1) Those blaming FM & FM need to explain why their low-income loans performed BETTER than the commercial ones that were made outside their control. (Alan Greenspan, for example, has utterly failed to do this.)
(2) Anyone claiming that legislation caused the crisis needs to explain why there were simultaneous housing bubbles in several European countries, despite the fact that they were not operating under U.S. laws. (This is not a problem for the theory that the financial industry caused it.)
(3) They also need to specify exactly what laws/provisions they mean. The Community Reinvestment Act of 1977 might be one such law, but it was modified in 1989, 1991, 1992, 1994, 1995, 1999, 2005, 2007, and 2008. What part of that was the problem, and why?
(4) They also need to explain why the 5 largest banks involved in the crisis (a) were not subject to the CRA and (b) did not issue any mortgages.
(5) And also why both the Financial Crisis Inquiry Commission “report” (written by 6 Democrats) and “dissenting statement” (written by 3 Republicans) concluded that government policies were not the cause. Dems: FM&FM “were not a primary cause of the crisis” and CRA “was not a significant factor in subprime lending or the crisis.” Reps: “Credit spreads declined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble. It also tells us that problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble.”