Inflation Adjusted Housing Prices

For many years in the early 2000s, people believed that “housing prices always go up,” and that “you can’t go wrong buying a house,” and that “houses are good investments”. At the same time, housing prices were reaching all-time highs not only in nominal terms but also in inflation-adjusted terms. Then from 2008-2012 these core beliefs were shaken and many people became disillusioned and decided that houses weren’t worth the hassle.

So the question remains are houses a great investment or not? Why would a depreciating asset that requires maintenance be a good investment? Logically, if a house is like other commodities, unless it has unique historical value, shouldn’t a new house be worth more than an old one? Old houses need repairs just like used cars so shouldn’t their price go down as cars do? Of course, older homes sometimes have better landscaping and other improvements than one fresh from the builder, but is that enough to make their value appreciate?

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 and by adjusting those prices for inflation we can get a better picture of how real estate prices really act…

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, homeownership is often the only savings program many Americans have. See “forced savings” below.]

Advantages of Buying a House:

1. A house is like a forced savings plan for people who typically aren’t in the habit of saving or investing.
2. 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 house’s value. 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%.
3. You can build “sweat equity” by improving the house through your own labor (untaxed).
4. Since you are paying it off over time, you are using “cheaper dollars” due to inflation to pay off the mortgage.
5. Houses are tangible assets (not paper), so their value tends to keep up with inflation (but not necessarily exceed inflation).

Disadvantages of Buying a House:

1. Incidental costs can add up: Taxes, Insurance, Maintenance, HOA fees, etc.
2. Leverage can work against you when house prices go down as they did in 2008, so the devastation is much worse than if you owned the house outright.
3. 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.
4. Houses are not “liquid”. It may take time to sell if you need to move.
5. 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.

S&P Case Shiller National Home Price Index

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 depreciating, while a few miles away, housing prices are skyrocketing. Still, by looking at the nationwide average, we can get a better picture of the overall trend. The St. Louis Federal Reserve published the following chart that shows the S&P/Case Shiller National Home Price Index (previously called the Case Shiller Housing Index until S&P started maintaining it).

I’ve added red arrows showing that home prices increased dramatically during the late 1990s and early 2000s. But then the market crashed, and prices fell until February 2012, when they bottomed at just under 134. From there prices have climbed steadily. So, in the early 2000s, everyone was convinced that real estate was the greatest investment of all time and that prices “always go up). Of course, whenever “everyone” believes something, the market throws them a curve. So, the housing index fell from around 184 to 134, losing about 27% of its value.

From 2020 onward extremely low interest rates helped boost property prices parabolically upward culminating in a mini-crash beginning in June 2022 when rates started rising. Surprisingly, housing prices started rising again in January 2023 as supply dried up and homeowners decided to keep their locked-in old lower rate mortgages rather than move.

Inflation-Adjusted Real Estate Prices

These prices are in “nominal” dollars. i.e., 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, based on the spreadsheet data maintained by Robert Schiller (of Case/Shiller fame), we can see the inflation-adjusted prices since 1902. This chart sets 2000 as 100.

This chart shows that housing prices were basically flat for almost 100 years (when adjusted for inflation). They fell drastically during the “Great Depression” of the 1930s (even in inflation-adjusted terms). Shortly after that, they rebounded and by May of 1975 housing prices (in inflation-adjusted terms) were only 1.1% higher than they were in 1890. This indicates that housing prices didn’t drastically beat inflation over this period, but they were still a great way to keep up with inflation.

From 1975 to 1995

Over the next ten years, inflation-adjusted housing prices increased by 9%, with a brief blip in the middle. So by May of 1985, the adjusted U.S. national home price index was up to 110.32. Over the next 10 years, the housing index once again blipped up and then fell to 113.45, so it had only gained a couple of percentage points. But in inflation-adjusted terms, that is better than losing money. But then the housing bubble began. However, the size of the average house also increased during this time negating much of the gain.

From 1995 to 2005

From 1995 through 2005, housing prices skyrocketed. In nominal terms, housing prices more than doubled. Even in inflation-adjusted terms, housing prices went from 113 to almost 196 (a 73% gain). Since most people are unaware of inflation-adjusted prices, all they saw was the nominal price increasing drastically.

So How Could a Bubble Like This Happen?

Part of the issue was that beginning in the 1980s, people started building bigger houses, which drove up the average price. In the 1950s and ’60s, the average home was less than 1200 square feet with two bedrooms and one bathroom. But then builders started adding a half bath (only sink and toilet), then it became a full second bath and then 2 ½ baths, with three bedrooms, and eventually, they became McMansions.

This was primarily the result of government policy changes not due to any intrinsic value in the cost per square foot. What happened was that the Democrat-controlled congress decided that everyone has the “right” to buy a house whether they can afford one or not. So 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 facilitated NINJA loans (No Income No Job No Asset Mortgage (NINJA) Loans). In other words, people who couldn’t afford the mortgage could still buy houses because lenders could make the commission on the loan and then offload the liability to someone else.

At the same time, the FED was following a loose monetary policy to goose the economy through the turn of the century because of the 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).

The reasoning was that most people wouldn’t default on their mortgages because you have to have somewhere to live.  So if you bundle enough of them together, the risk to the whole package becomes very low. With this low-risk package, 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. See The Big Short by Michael Lewis for more details.

Housing Prices Since 2005

From 2005 to 2012, housing prices returned to reality (considering the increased house size). But once again, the FED had embarked on a massive money printing binge, including several massive Quantitative Easing (QE) plans. Some of this vast money printing reinflated the stock market, but some also flowed into the housing market.

Source: St. Louis Federal Reserve.

The FED briefly tried to reduce the massive money creation scheme with QT, which resulted in a 20% stock market crash, so they abandoned that idea. For more info, see NYSE ROC.

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” totals 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.”

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

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