I’ve just returned from a conference with a bunch of really smart people, all of whom write personal finance blogs, have published books about personal finance, or report on finance issues for national news outlets. Like I said, smart people.
While I was at the conference a number of folks asked me if I thought home values would continue to rise. Each time this generated a robust conversation revealing quite divergent views on the matter. Clearly, this is a topic that is at the top of many people’s minds. If you don’t own a home you want to know if housing prices are going to get even further out of reach; if you do own your own home you want to know how much your equity is growing.
Once camp believes real estate is back, while the other thinks it has come back too fast and too high, and is bound to correct again. Who’s right?
According to a report by Zillow price appreciation slowed nationally in August to a 1.2% annualized rate, compared to a 6.6% rise in the preceding 12 months. No one can say for sure if the nominal rate of inflation we saw in August will carry forward, but it is certainly noteworthy.
Core Logic, a leading property information, analytics and data provider, in a press release dated September 2nd, predicted an increase home prices in the coming year of 5.7% nationally, so someone is at least trying to make a guess.
According to Wall Street Daily in an article published on August 5th of this year, however, real estate prices are expected to do no better than keep up with inflation, and in the short run may even under-perform. This conclusion was despite the citation of a Gallup poll in the article of a broad sampling of Americans showing that when asked which class of returns they expected to generate the best returns was, real estate was the clear winner with 30% of respondents choosing it.
Reasons most often cited for continued appreciation above the inflation rate are:
- Pent-up, unrealized demand from home buyers who sat out the market during the recession
- Expanding job market
- Low interest rates and high affordability (nationwide)
- The foreclosure crisis is winding down; there will be fewer distress sales in the coming years, and so less pressure on prices.
- New loan products entering the marketplace will expand ownership opportunities to prospective home buyers who would otherwise not be able to obtain financing. (i.e. self-employed business owners)
Reasons most often cited for appreciation at or below inflation are:
- Interest rates will rise in the next two years
- While the job market is rising, real wages are not for most people
- Millenials (as a group) no longer believe that homeownership is a given
- Re-casting of interest-only loans, including equity lines, written in 2003 – 2007 will cause a radical jump in monthly payments for many homeowners, and many of them will be forced to sell under duress.
While the pundits argue about whether or not the returns are competitive with real estate, however, there are several points missing from the discussion:
- Most people don’t buy a home to make money. They buy a home because they have to live somewhere, and owning a home gives them more stability.
- Real estate is the most highly-leverage asset class. It is arguable whether it is wise or not, but one can finance up to 100% of the purchase price of a home; not so with any other investment asset.
- When the home appreciates, you earn that rate of return not only on your equity, but on the bank’s equity (the loan balance) too. Of course, leverage works both ways – it can lead to big losses as well as big gains. (The subject for the next blog.)
However, remember that all real estate is local. In sellers’ markets (think areas with great job markets, like Silicon Valley) a strong rise in home prices is likely to continue for a while; at least until the job market cools, and no one is predicting that.
So who’s right?
The pace of home-price inflation is certainly cooling, and nationally it would make sense that in the long run home prices will rise about in line with inflation. After all, home prices are the single largest factor used to calculate the CPI. It would be foolish to think than over time they would not line up.
In strong markets, however, the pent-up demand and historically low interest rates will drive price appreciation higher than the CPI for a while longer.
Finally, don’t take this issue too seriously. In our conversations this weekend opinions were strong, arguments were made skillfully and passionately, and it felt like the stakes were high. But in the real world, people buy a home to have a place to live, to raise a family, to call home. Keep that in mind if you’re considering a purchase.
Casey Fleming Author of The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)