Rejoice! Your House Is An Investment Again
Good news for homeowners – your house is appreciating in value! The housing bubble (and bust) is over and prices are now poised to appreciate with the inflation rate, as they should.
Bubbles occur in all asset classes and housing is no exception as Figure 1 illustrates. The average U.S. home price doubled in value on an inflation-adjusted basis from 2000 to 2006. The housing bust only took a few years to bring home values back to their long-term average.
Figure 1: Average US Home Price Index after Inflation
Sources: Freddie Mac, FHFA, S&P/Case-Shiller Home Price Index, CPI
Housing prices got out of hand for many reasons. Many people have an opinion about why it happened; I have several.
Taxes: Liberal tax breaks enacted in 1997 allowed up to $250,000 of tax-free gains on the sale or exchange of a principal residence ($500,000 for married couples filing a joint return), and this is after deducting mortgage interest on a tax return for mortgages up to $1,000,000 and $100,000 for a home equity loan.
Easy Credit: Lending standards disintegrated at financial institutions. Marginal buyers with little credit were invited into the market and qualified for new types of loans where they made minimum payments in the early years of a mortgage. The idea was that prices would continue higher and the homeowners could refinance.
Greed: The stock market waned after the tech bubble burst in 2000, while home prices rose. Expectations for continued price increases led to widespread speculation among individuals who had never been in the housing market before except as a homeowner. I knew the top was near when one former client liquidated his IRA account to speculate on two Florida homes in 2005.
The house of cards began to shake in 2006 and it collapsed in 2007. Prices cascaded down. The bottom was finally hit in the first quarter of 2012.
That’s all water under the bridge. Home prices have retrenched back to where they should have been all along. Nationwide, homes are selling about where they were in the year 2000 after adjusting for inflation. That’s the normal growth range.
Am I saying that prices are building a base from which to catapult north again? I certainly hope that doesn’t happen. It would be bad for the economy and eventually lead to another financial crisis.
What I am saying is that it’s okay to buy a house today. Prices are back to normal and interest rates are low. From this point, home prices will likely appreciate with the inflation rate providing the property is kept up.
Washington also seems willing to help. Federal Reserve policy is to keep mortgage rates low, and the interest mortgage deduction will probably survive the next round of tax increases. This should keep a new homebuyer’s interest expense down around the inflation rate after tax.
There’s also good news for sellers. There hasn’t been much talk in Washington about cutting the $250,000 tax-free capital gain on the sale or exchange of a principal residence ($500,000 for married couples.)
Owning a home may not lead to speculative windfall profits that some people earned a few years back, but it beats paying rent. If you can turn rent into something that appreciates with inflation, that’s a good investment.