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:
- A house is like a forced savings plan for people who typically 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 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%.
- 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 tangible assets (not paper), so their value tends to keep up with inflation (but not necessarily exceed 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, so 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.
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.
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 1890. This chart sets 1890 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.”
amazing data. thank you Tim Mac
“Democrat-controlled congress” why inject the into a otherwise good analysis
Why do you bristle at the truth?
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.
I would very much like to see an updated chart now with the Coronavirus and the Fed pumping trillions into the economy.
Trevor,
We’ve updated the housing chart and added data all the way back to 1890.
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.
Why are you such a happy person?
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.
Home prices went up 25% since you posted that. WIth 3% down on a $300K (cost = $9k), it would now be worth $375K … that’s an 833% gain on the $9k invested over 3 years. Of course few people saw that covid would have caused that. At this point I’d say it’s a good time to sell then rent for the next 12-24 months, then buy again after this market corrects.
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.”