Are you waiting for home prices to undergo a massive correction before buying your first – or next – property? If so, stop.
I know, logically, it makes perfect sense. There was a massive run-up in home prices during and after the pandemic, unaffordability is at an all time high, surely these astronomical prices have to fall back to earth at some point, right? That was my thinking for the first year and a half of what we’ll call the “Pandemic Bubble,” but I realized this was the wrong perspective when activity in the housing market fell off a cliff. When sales slow down, in theory, prices should drop. But they did not. Nationwide, they’re flat. I needed a new mental model for the real estate cycle. Jason Hartman – a real estate investment specialist – says it’s important to look at prices on a “real” basis. This means “adjusted for inflation.”
In this inflationary economy we live in, residential real estate is not a good or service, it’s an asset class. Houses are big heaps of scarce commodities, arranged in a specialized fashion using scarce labor, on top of a resource that is nearly impossible to make more of – land. It’s economically “wired” to go up in price slightly faster than the prices of goods and services, which have increased by an average of 3.5% a year since World War II. On average, the median home price rises about 1 percent faster than inflation each year. All this is to say, that to get a sense of the real trend in home prices, you must adjust them for general inflation.
And according to that model, the infuriating truth is that home prices have been falling, the down part of the cycle is underway, and has about two years left to go.
See the lower of the two charts above. On an inflation-adjusted basis, home prices follow a cyclical pattern that is exceptionally clean, at least, compared to other “cycles” in the economy. The real median home price deviates upward from its trend by about 12 percent, reverts to trend, then falls below the trend by about 11 percent. We’ll call this the “real” median home price index.
It takes 3-4 years for the corrections to play out from peak to trough. We’re already two years into the “down” part of the cycle. The real median home price, down 14 percent, has reverted to trend. It has another 11 percent to fall before starting a rebound.
If we have average inflation of 3.5 percent a year, over the next two years, 7 of those 11 percentage points of decline will be taken care of by the economy-wide rise in prices. That leaves only 4 percent for the “sticker” price of the median home to fall. What’s 4 percent of $412,000?
We’ll round to $16,000. At current 30-year mortgage rates of about 6.75 percent, that will reduce a new mortgage payment by a hundred bucks. Is that worth rearranging your life plans? Probably not.
People whose goal it is to get into a house, should do exactly that. If you can’t afford the houses in your area now, you’re not going to be able to after a 4 percent drop in 2 years. The way to solve this problem is not to wait, it’s to do what people have always done, and find a smaller house, or a house further away from the city center.
If that compromise is unacceptable, fantastic! You value being close to the city more than you value living in a home you own. And that is a-okay. Here’s a secret: the home you live in is a terrible investment. Its value is only going to beat inflation by one percent a year (stocks average 6), its age automatically makes it less valuable, and every emergency repair is at least a thousand dollars. Fortunately, we don’t have wealth taxes on investment portfolios in the US (yet). But we do have local property taxes, effectively, wealth taxes on houses.
Lastly, don’t wait for a drop in rates, either. The average 30-year mortgage rate for the last half century was 7 percent. According to the weekly Freddie Mac survey, we’re hovering around 6.75. In the next 30 years, rates will go higher than they are now and go lower than they are now. If they go down, you can refinance, if they go up, you’ll be glad you locked in 6.75. It has never made sense to wait for a lower rate, not even in 1981 when a 30-year fixed was over 18 percent.
As is true with many things we want, if you want to buy a house, the best time to do it was ten years ago, the second best time is now.