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How to Think About Home Price Appreciation

Your home is your castle, and if you’re like most Americans, it’s also the single largest component of your net worth. Naturally, you would love to see your home appreciate in value over time. But by how much? What’s a reasonable expectation? To answer that question, let’s take a look back at history …

Since 1891, U.S. home prices have increased 3.4% per year before inflation (“nominal”) and 0.5% after inflation (“real”). Over long periods of time, there’s been a high correlation between changes in overall inflation (CPI) and changes in home prices, with the two variables generally moving in tandem.

Before 2000, we had never seen U.S. home prices outpace inflation by more than 33% on a cumulative basis (since 1891). Few considered their primary residence to be “an investment” in a similar way to stocks or commercial real estate.

But that thinking completely changed during the housing bubble of the early-to-mid 2000s, when home prices exceeded the U.S. inflation rate by an unprecedented margin (99% by the end of 2005). This led many to believe that houses were not only investments but a better option than stocks because they “never went down.”

And then, of course, prices went down. From 2007 through 2011, U.S. home prices fell every single year, declining a total of 26% on a nominal basis and 35% on an inflation-adjusted basis.

But the story doesn’t end there. Fueled by a desire to create a so-called “wealth effect,” the Federal Reserve attempted to boost the value of housing and other assets, holding interest rates at 0% for a record seven years (from December 2008 to December 2015) and purchasing a record amount of bonds (Treasuries and MBS) to artificially suppress interest rates. At the same time, the U.S. Government created a homebuyer tax credit (2008-10) and borrowed trillions of dollars, sending three rounds of stimulus checks to most Americans (2020-21).

As a result, we saw a second U.S. housing bubble take hold. Home prices more than doubled in the 10-year period from 2012 through 2021, surging to a new record of 117% above inflation.

When mortgage rates spiked higher in 2022, the median home in the U.S. quickly became even less affordable than in the previous bubble, and demand for housing collapsed. 2022 was the first year since 2011 in which real home prices declined.

What does this history tell us about the future of U.S. home prices? In the short run, not very much.

Why? Because there’s a myriad of factors impacting the housing market, including supply/demand, affordability, inflation, economic/wage growth, availability of credit, mortgage rates, unemployment rates, demographics, sentiment (fear/greed), Fed/Government policy, etc. The cumulative impact of these factors can lead to vast differences in appreciation rates from one year or one decade to the next.

That said, for homeowners who plan on staying in their house for a long time (i.e., 30 years), what they’ll likely find is an appreciation rate that doesn’t deviate too much from their local rate of inflation. This has been true of the overall U.S. housing market, which saw real prices rise 2.2% per year in the best 30-year period (1976-2005) and real prices fall 2.0% per year in the worst 30-year period (1895-1924).

During the twin housing bubbles of the past twenty years, we’ve seen record real price appreciation that in turn has created unrealistically high expectations about future gains. But there’s no reason to believe there’s been a paradigm shift where the laws of economic gravity no longer apply. For when housing prices deviate too much from the rate of inflation, there’s a natural correcting mechanism in that supply increases (more homes are built) and/or demand decreases (fewer people buy homes as they become less affordable). This is intuitive, for homes should ultimately be priced based on the cost to build/maintain them and your ability to afford them (wages), which are both reflected as part of the inflation rate.

So if you just bought a house, how much should you expect it to appreciate? Only a little bit more than the rate of inflation in your area, with the understanding that it could very well be less.

Importantly, the price of a home doesn’t include the many other costs associated with home ownership (mortgage interest, taxes, insurance, closing expenses, repairs, maintenance, capital improvements, etc.). If you’re evaluating a home as “an investment,” a true rate of return would need to include these costs as well, making the analysis much more complicated.

This is why buying a home to live in should be viewed very differently than passive investments such as stocks and bonds. Your home is your castle and should provide benefits beyond just the numbers. Price appreciation is only one part of the equation.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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