Where Is The Housing Market Headed?
By: J SCOTT

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The biggest question on everybody's minds these days is where is the real estate market headed? And while, on the surface, this may seem like an impossible question to answer without having a crystal ball, there's reason to believe that the answer is fairly obvious.

But, in order to fully explain, let's step back and take a look at some history around housing values...

Here's a graph of median home value (indexed) from 1900 through (almost) today:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It shouldn't come as much surprise to see the up-and-to-the-right hockey stick shape of this graph.  We all know that housing has gotten much more expensive over the past 40 years, and especially over the past 20. 

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But, let's dig in a bit further...

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I've talked a lot in the past about how real estate values have tracked inflation for much of modern history.  But I think a lot of people don't quite get how strong of a correlation we've seen between housing value increases and CPI inflation.

This graph adjusts median home price values for inflation (often referred to as "real housing values") -- from 1900 through 1998:
 

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To provide some context, here is the same graph that includes a trend line that represents what housing prices would look like if they exactly tracked inflation over that 100 year period:

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As you can see, values sometimes lagged below the inflation trend and sometimes hovered above the inflation trend.  But, for pretty much all of the 20th century, home values moved hand in hand with inflation.  To the degree that many economists today are comfortable saying that real estate values historically track inflation.

That's the data from 1900 through 1998.  But, things started to change about 25 years ago.  From 1998 through 2006, we saw a big deviation in home value increases from that inflation trend line.

Over the 8 years from 1998 through 2006, home prices appreciated much faster than inflation would have predicted:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

But we all know what happened shortly thereafter...  From 2007 through 2013 home values plummeted.

Where did they plummet to? Pretty close to that historic inflation trend line:
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

So, using the data above, it appears that from 1900 through about 2013, home values have tracked inflation. Even with that major deviation from 1998 through 2006, within just a few years, we saw a reversion back to the long-term trend.

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Okay, so back to our graph...  Around 2014, we started seeing another major deviation in home values away from the trend line.

Which has lasted through today:
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

If, like me, you're a believer that economics isn't random and that economic history is a good predictor of economic future, you're probably comfortable agreeing with me that we are eventually going to see home values return to the inflation trend line.

So, when somebody asked me where real estate values are headed? There's the answer:
 

Values will return to the trend line.
 

Now, that doesn't mean that a 2008 type crash is in our future.

Of course, that's one possibility.  Like, during the Great Recession, we could see a collapse in real estate values sharply and quickly, taking us back to the inflation trend line in a matter of months or a couple years.

But there's another very real possibility...

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It's possible that we could see home values flatten out for several years, while inflation continues at its historic -- or even above historic -- averages.  If inflation continues, but housing values stop increasing, eventually the trend line will catch up with current values and we would return to the trend line. 

In this case, we wouldn't necessarily see a crash in values, but we would see a plateau in values for anywhere from 3 to 10 years, depending on how high average inflation is and whether prices come down at all to meet the trend line.

Long story short, it's fairly obvious to me where values are headed (again, back to the trend line). It's just a question of how they get there and how long it takes.