What to Expect from House Prices

I feel a little silly doing this, but it seems like I need to make that case that house prices are important.

You might recall that the Great Recession started with a fall in house prices. A mountain range of bad mortgages and the bonds that they were packaged Perce_cliff_house into got most of the attention, but let’s remember that the whole sub-prime accident-waiting-to-happen wouldn’t have existed without a decade long run up in house prices. And if that run up had by some miracle continued, the accident would be still waiting. (And getting worse.)

But even if American house prices hadn’t recently been the rug that got pulled out from under the global economy, it’s a topic of huge importance in the world of personal finance. More than two thirds of American households own the place that they live in. For nearly all those households, the house is the largest single asset and one bought with mostly borrowed money.

(By the way, if you are thinking that the two-thirds owning homes is a result of recent and possibly regrettable government policy, you’d be wrong. It’s been in that ballpark for a long time.  It was 68.9% in 2005, all the way up from 62.1% in 1960. And a lot of that 6.8% increase was mere demographics, e.g. the Baby Boomers got married and bought a place in the burbs.)

So how come I seem to be the only one obsessed with house prices? I’ll admit that the US house market is not as volatile or as interesting as a spectator sport as the US stock market. But the two markets are roughly the same size and have a similar importance to the economy. And the stock market has entire cable TV networks devoted to it.

The media does cover the housing market, but not all that well. To be fair, it often seems like they spend more time and ink on house prices than their viewers and readers really want. As shallow as the reporting is, I get the impression nobody is listening.

Last weekend Brett Arends ran a piece on the Wall Street Journal on the  beginnings of a recovery in house prices. Towards the top he discussed the fact that the Case Shiller 20 City Composite was down only –0.2% in May. Except that it was up 0.45% in May. (I think he meant the rarely cited seasonally adjusted version of the index, which was, in fact, down –0.159%, and which a non-obsessed person might round to –0.2%.) Of the 29 comments on the article posted by Wednesday, how many do you think mentioned this inconsistency? Not a one. Imagine what would have happened if he had gotten the direction of the monthly return of the S&P 500 wrong.

The rest of the article is about how although house prices may have stopped their long march downward, you shouldn’t expect a sudden V-shaped recovery. I basically agree, although I do remember all us sober types saying the same thing about the stock market just before it went up 50% in a head-jerking hurry.

In the short term, the next 12 months or so, I expect something like we’ve seen very recently, with modest increases in most of the country balanced out by continued problems in South Florida and the Southwest. But short term predictions, while fun (particularly for those who get to mock me next year when I turn out to be wrong) aren’t particularly useful.

For most folks, what is important is the long-term outlook, what to expect for the years and even decades to come. Most households will wind up owning the roof over their head. But how much roof they buy, and the plans they make for how they spend and save the rest of their income have a lot to do with what they expect to happen to the value of that roof in the long run.

As I wrote back in February (in what is still one of my favorite posts) I expect house prices to track inflation over long periods. Maybe a tad more in places with vibrant economies and nowhere to build more houses (e.g. New York, Boston, San Francisco) and maybe a tad less in places with challenging prospects and/or an inexhaustible supply of house lots (Detroit, Las Vegas.)

But the basic story is that houses track inflation, i.e., they hold their value in real terms, assuming you pour money into them to keep them maintained and up to date. I’m not going to answer the philosophical question of whether or not houses are an investment. It is possible to get rich from the house you live in, but not very likely.

Owning a house often (but not always) makes sense because it is the most cost-effective and satisfying way to buy shelter for you and your family. Buying more house than you need as shelter because you expect to sell it later on at a profit is generally a poor idea. But so is buying less because you fear selling at a loss.

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