Interest Rates, Inflation and Home Prices

[XBoxBoy]

Another interesting insight when using data from Jan. 1977 is in this chart. This compares the deviation of the Case Shiller price from the XValue:

What I notice in this chart is that in 1980-1983, when interest rates were so high (mid teens!) prices people were paying were way above what we would expect based on the XValue. But we don’t think of that time as a bubble, because within a couple years interest rates had started their long march downward, and so people could refinance out of the high rates. Also, during the next few years prices didn’t grow much. So, I wouldn’t call it a bubble, since it never popped.

Which tells me, that just because prices go way above the XValue, we shouldn’t assume we are in a bubble. If it is followed by a period of lowering rates the XValue could increase rather than prices collapse.

[gzz]

The deviation I believe is explained mostly by the expectation that high rates will go down, and the very powerful behavioral economic concept of sticky downward prices.

The weakness of my first point is that the high long rates in the late 70s and early 80s reflected market expectations. The counter to this is that expectations of homebuyers and investors are not the same as major bond buyers, and also that the homebuyer only needs to hope rates dip once so they can refi. Further, lower liquidity in RE means marginal buyers expecting rates to dip have more power than in liquid bond markets.

Another thing keeping RE high when high rates make it unaffordable was the concern about runaway inflation. Those long bonds with 13% coupons were great in retrospect, but had a much worse downside than RE if inflation had moved into the 20%+ range.

[Rich Toscano]

Good stuff xbox, thanks for putting in all this effort. I think the experience of the early 80s can also be interpreted that the inverse relationship between interest rates and asset prices is not written in stone.

GZZ alluded to one possible reason why, which I’ve always been partial to. Buying a house is prepaying your rent for life, and thus, eliminating the risk of rental inflation. So the value of home ownership should (all other things equal) be higher if people are expecting high rental inflation, and lower if they are expecting low inflation. This factor would INCREASE values (again, all things equal) during periods of high inflation*, and decrease them during low inflation. This could partially offset the intuitive relationship between rates/monthly payments and prices.

* (what matters here is future inflation expectations, not trailing inflation… but people being natural extrapolators, the former usually just follows the latter).

[sdrealtor]

Intersting point on expectations of future rent inflation. I never gave any thought to that beyond locking in one’s housing costs at an affordable rate for life.

[Reality]

[quote=Rich Toscano]Good stuff xbox, thanks for putting in all this effort. I think the experience of the early 80s can also be interpreted that the inverse relationship between interest rates and asset prices is not written in stone.
[/quote]

Nobody knows how much higher asset prices might have gone without the interest rate policies of the time. Both going up at the same time is evidence of nothing.

[sdrealtor]

[img_assist|nid=27386|title=Home Buying Opportunities over our lifetimes|desc=|link=node|align=left|width=100|height=73]

From time to time I kid our resident permabears that they missed the opportunity of a lifetime. Yesterday I was on my weekly call with a SoCal housing economist who posted this. It actually covers homebuying over our lifetimes. Hard to argue that buying a home around 2009 to 2012 was not the opportunity of lifetime looking at this.

[XBoxBoy]

[quote=sdrealtor]Hard to argue that buying a home around 2009 to 2012 was not the opportunity of lifetime looking at this.[/quote]

Yup, absolutely agree. If you look at the chart above showing deviation you find it agrees with your housing economist. 1997 to 2000 was a good time, and then again 2010 to 2013 was an even slightly better time.

[scaredyclassic]

[quote=XBoxBoy][quote=sdrealtor]Hard to argue that buying a home around 2009 to 2012 was not the opportunity of lifetime looking at this.[/quote]

Yup, absolutely agree. If you look at the chart above showing deviation you find it agrees with your housing economist. 1997 to 2000 was a good time, and then again 2010 to 2013 was an even slightly better time.[/quote]

I’ve missed so many opportunities, they barely register. But even a dope does something right occasionally

[XBoxBoy]

Here’s an updated version of the chart comparing the Case Shiller to what we would expect the price of a house to be based on historical inflation and mortgage rates. Just to remind you the red is Case Shiller and the blue is the expected price.

I’m guessing that most of you will find that to be a pretty big eye opener, like I did. It shows that things are way more out of balance than I expected. Of course we all know things are out of balance, prices shot up the last two years and now that mortgage rates are rising, this has really opened the gap between where prices are and where they should be based on inflation and mortgage rates.

For those of you who prefer a log scale here’s the same data but with log scale for price:

When viewed with a log scale (which arguably is the correct way to view this data) things look less dramatic, but still a sizeable imbalance.

After looking at this, two questions come to mind for me.
1) What will be the path that brings these two back in balance?
2) How long will that take?

(On a side note, I also wonder if it is reasonable to expect that these two do come back in balance. Most the time I think about this, I come back to thinking they should, but I’m open to anyone who’s got a good argument why this isn’t so.)

Anyway, I’ll post the above now, and potentially later I’ll share some charts about where these graphs go with various assumptions (guesses!) as to where inflation, mortgage rates and prices go. If anyone has a scenario they think is particularly likely feel free to post and if there aren’t too many I’ll try to create the charts that show how that plays out.

[XBoxBoy]

Here’s the deviation chart btw:

[sdrealtor]

Really is a dramatic shift and in an incredibly short time. One has been on a path essentially moving straight up and the other suddenly went straight down. Absent what makes real estate unique this situation would most assuredly precede a dramatic drop. What we don’t know is what happens with supply with so many locked into such long term low rates? It’s gonna make moving tough to impossible for many even if they could sell their home. Nothing would surprise me going forward

[flyer]

Things really are starting to get interesting. Not really looking for more rentals, but always open to new opportunities. Otoh, really don’t want to see the country continue to go through even more economic pain. Guess we’ll have to wait and see how it all goes.

[The-Shoveler]

LOL interesting times for sure.

IMO true RE is a local thing mostly but it is also a national thing if the whole country goes recession.

IMO if housing (nationally) goes into recession the whole thing goes into recession, then the fed will need to start worrying about deflation.

The issue is IMO, the fed wants a housing reset, the problem is there is no such thing as a housing reset that does not take the whole economy with it.

[flyer]

Could be, TS. So much of what we are experiencing is uncharted territory due to the pandemic, and for some other reasons, so, imo, anything is possible.

Sadly, all of the volatility in many sectors, is most affecting those who can least afford it, which is a substantial portion of those in our country. We can only hope there will be some meaningful resolutions sooner rather than later.

[Author]

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