Some Thoughts on the Future of Home Prices

I was reading this report from Zillow on the future of home prices and it got me thinking about some of the macro trends in real estate.  I’ve turned much more constructive on housing in the last year than I had been for the past 5-6 years.  Before about 12 months ago I wouldn’t have told anyone to purchase a home in the USA, but about a year ago I started saying:

“If you’re planning on living in a house (as in, 10 years of actually living in a home) then you should have no great fears about buying today.”

Admittedly, the year over year surge in home prices has been greater than I expected, but the halt in price declines doesn’t surprise me at all.  After all, we’ve fallen 30%+ from the peak in many areas so the risk/reward structure of the real estate market has shifted favourably for buyers.   But I do worry that the misconceptions regarding housing persist as this quote from the Zillow report implies:

“We’ve just finished compiling our Q1 2013 Zillow Home Price Expectations Survey (ZHPES), where professional forecasters provide predictions for housing market growth in the near term. This survey marks a break with the past in that the survey benchmark is now the national Zillow Home Value Index rather than the Case-Shiller index. The prediction for appreciation in 2013 is 4.6 percent, with the lowest projection at 3.5 percent depreciation and the highest at 8.5 percent appreciation. This edition of the survey was compiled from 118 responses, including the projections of economists, market and investment researchers and real estate experts.

It’s also interesting to break up the market by growth periods to compare historical annual average rates to expectations, as done in Figure 2 above. Covering expectations for annual average growth to the end of 2017, the average of all respondents, at 4.1 percent, is above the pre-bubble average of 3.6 percent. Indeed, the optimists, on average, seem to expect the recovery to continue modestly picking up speed. And while on average the pessimists expect things to slow, it would not be too far below the pre-bubble average.”

Real estate returns are not rocket science.  Because they’re such a huge portion of the consumer balance sheet they tend to be tied very closely to wage growth.  Wage growth, by definition, is very closely tied to the rate of inflation.  That explains why the long-term historical return of real estate is roughly in-line with the rate of inflation.  But this survey from Zillow shows that real estate “investors” are probably still too optimistic.

I’ve compiled the same data using the Case Shiller nominal price index in figure 1 below.  US real estate has averaged about 3.7% since 1890.  That’s just a tad above the average historical inflation rate of 3.2% in the USA.  When I started calling housing a bubble back in 2005 it was largely due to this one simple mathematical reality – house prices cannot deviate from wage growth in perpetuity.  So when Robert Shiller started posting his famous inflation adjusted house price chart (figure 2) all over the place it should have sent us all into a worried frenzy.  But it didn’t for some reason.  Instead, most people shrugged it off and it directly contributed to one of the worst economic calamities in US history.

Looking forward, I wouldn’t expect house prices to break their bubble peak until about 2025.  Figure 1 shows the historical Case/Shiller data with Zillow survey results.  The most probable scenario (historical average) assumes a real return of about 0%.  But the average respondent to the Zillow survey expects 4% nominal growth.  That sends us back to new highs by 2022.  That’s not terribly unreasonable.  But the most optimistic real estate investors are expecting something closer to bubble-era nominal growth of 6% per year.  That gets us back to the bubble peak by 2019 and sends us shooting 41% over that level by 2025.  That’s just not realistic and not sustainable in any way.

Of course, the future won’t play perfectly to the averages or even my practical assumptions.  It’s entirely possible that the Fed’s implicit asset targeting approach will veer us closer to something like the “most optimistic” scenario.  Combine that with the broadly held myth that housing is a good “investment” (it’s actually a crappy investment in terms of  real, real returns) and we might have all the ingredients for the highly unusual post-bubble bubble.  I for one, hope prices stagnate with inflation rates and basically move sideways per the Case-Shiller chart, but I’d be lying if I didn’t say I am getting at least moderately worried about the impacts of the Fed’s policies at present.  It’s way too early to start declaring this an environment consistent with a disequilibrium like 2005, but we should be proactive thinkers, not reactive like our friends at the Fed.

(Figure 1 – Housing Scenarios via Orcam Research)

(Figure 2 – Real House Prices via Orcam Research)



Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. The housing market is already booming in many places. Low interest rates and continued QE will only spark this further. I wouldn’t be shocked to see another bubble.

  2. Cullen,

    I think you are right. The only question is, should you make an adjustment for negative real interest rates. If we look at 2000-2007 period, they may have contributed strongly in the previous bubble. Now, they are probably contributing strongly in the RE prices stabilization and growth is some areas. If we assume the fed can manage to maintain negative real interest rates environment, and push mortgage rates down still, we can easily have an “optimistic” scenario provided the current wage/CPI growth is maintained.

  3. Some good points.I think it is uncalleable,because the low and high expectations that define the fture point in time at which prices fully recover will be very much driven by exactly how long current monetary policy is extended.That policy is really distorting some relationships between wages/inflation/house pricing.
    You see over the very long haul you can zero in on wages. There is however room to say that it is disposable income rather than wages that creates a ratio with house prices. Keeping rates and financing costs lower than historically normal creates room for above average speed of recovery in prices.Now that becomes even more the case IF you believe also that the US will have more control over imported energy costs going forward thus have more control over inflation arising from energy costs. This again gices rise in effect to psuedo rise in disposable income in the sense of discretionary choice.that is what you don’t have to spend on energy you spend on something else right? That somethingelse could well be housing again.

  4. By the way we have seen this before guys. Post 70’s energy shock where once the increase in energy costs had been taken and absorbed we then enjoyed more discretioanary choice re disposable incomes .Like I said before nothing really new out there.

  5. What worries me most is when politicians start meddling with housing. When they encourage the policy of achieving a high home ownership rate for me it is the biggest threat for an economy, and a “Weapon of Economic Destruction”.
    If people are struggling to raise large deposits required to secure a mortage, should the government encourage them to leverage too far in the first place?
    In 2010 Sweden passed a law limitating the maximum Loan to Value (LTV) to 85%. In effect, Swedish people will need to put down a minimum of 15% of deposits to borrow 85% of the remainder

    For instance, the latest UK proposal by Osborne is pure madness:
    Osborne pledged 3.5 billion pounds ($5.3 billion) to help buyers of new homes with loans of as much as 20 percent of the property’s value, broadening an existing program beyond first-time purchasers. He also announced a plan to guarantee as much as 130 billion pounds of new mortgages to fuel demand from purchasers with limited cash for a deposit.
    The government whose excessive prudence has discouraged banks from offering mortgages worth more than 75% of a home’s value, will now guarantee borrowers who have a 5% deposit the additional 20% loans they need to qualify. In doing this, the Treasury will expose itself to any falls in house prices beyond 5%—and this exposure will not be included in national debt statistics.

    Lessons learned in the UK from the US housing debacle? Not really…



  6. The appraisal process will keep home prices in check for a while. Banks won’t loan $450K for a house when the appraisers are still stuck at $280K. It’s slowing things down where I live, anyway…

  7. Interest rates have been low for almost 4 years and if you look at the chart above-we have a blip higher after a 30% hair cut. I own a house and hope I am dead wrong-but the numbers don’t add up for any type of sustained real estate recovery-unless Ben causes some type of hyper inflation, which we know has not happened.

    Baby boomer are downsizing. That will be the largest supply of real estate we have ever seen coming down the pipe. Foreclosures will add to that inventory. Now take the people who are getting foreclosed on-remove them from the “demand pool” for at least the next 7 years. Now take students coming out of college “potential demand pool” and place a $100,000 debt sticker on their forehead and that is why I don’t see real estate doing anything but poss. even heading much lower in the next 15 years.

    Like I said, I hope I am wrong-as I am a home owner

  8. I read that article this morning (in the WSJ). I found it interesting that the investors mentioned in the article are saying that they intend to hold their portfolios of rentals long term. I guess we’ll see about that. I remain skeptical about the costs of managing large portfolios of detached, single family homes. This same concern was mentioned in the article, although just barely.

    Large, well capitalized investors like Blackstone may well have scooped most of the bargains. I live in Florida and know many, many realtors. This is just anectdotal, but I think true investor activity has slowed considerably.

  9. One interesting observation is that in the last 2 years wages/(household debt) has increased … for the first time in ~50 years and only the second time post WWII! Could this be a secular shift in attitudes toward housing and saving?

  10. To appreciate the current dependency of house prices on the Fed’s monetary policy of ZIRP–zero percent interest rates–please consider the following: Since World War II until ZIRP, the average US mortgage rate was about 7 1/2%. It currently is about 3.7% for a 30 year fixed mortgage, the 30 year fixed being the most common and traditional mortgage. If mortgage rates normalize, returning to 7 1/2%, the monthly payment on a 30 year fixed mortgage will increase by 50%. The negative effect on house prices would be substantial, to say the least.
    Additionally, please consider that most people buy all the housing they can–they have no room to make a larger monthly payment. So indeed wage inflation is the only means whereby buyers can buy more expensive homes. Yet if there were such inflation as to cause wages to begin to adequately compensate for a return to normalized mortgage rates, two things would likely happen: wages, even though rising by inflation, would fall behind such a rising general inflation rate; and mortgage rates would rise well above the historical average. Both of these things happened in the 1970s. Early in the decade, wages kept pace with inflation and then fell behind; and by the end of the 1970s mortgage rates were around 14%! The booming real estate market of the 1970s thereby meet its demise.

  11. OK, so let me highlight just how appropriate the name I am using on this blog is by making a few observations and then asking for some clarification.

    1) I believe CR and many others on this site think residential RE is a lousy investment based on real, real returns relative to other investments (as highlighted in the article CR discussed previously).

    2) Many RE transactions include a mortgage – and “typically” with 20% down.

    3) If my assumption is #2 is accurate, let’s assume for easy math the purchase price of the home used for a primary residence is $100k. I must come out of pocket with approx $29,000 ($20k down, $6k for commissions and $2-3k for loan fees). If the property appreciates per CR’s comments above at 3.7% then in year 1 appreciation = $3,700. so a return of $3,700 on a $29,000 investment is ~ 12.8%. Of course, if you sold the home right away, you would have another $6-8k in commissions to realize the gain, but wouldn’t that put your return right around 10%? And what happens if you hold for at least 2 years – your return would be tax free. I know this doesn’t take into account other expenses like maintenance, moving costs, etc, but it also ignores other benefits such as tax deductions, rent vs. buy differences btx similar properties, principle reduction, etc. And yes, at the end of the day I know this is an example of leverage, and leverage can be used on other investments. However I do believe for RE there are many opportunities to acquire property at less than “market value” (in particular the last few years), boosting one’s “return”.

    Anyway, there are my observations and questions, let the beatings begin.



  12. Please note, I just realized I accounted for commissions twice in the hypothetical transaction above when in reality it hits only once.

  13. What you are describing is not so much an investment as it is a leveraged play.
    So if the house falls in value by 20 percent, you’re going to lose 100 percent of your investment, plus costs and fees.

  14. The biggest costs of homeownership are upkeep and the mortgage itself. If you put 20K down then you’re still paying 6% (average) on 80K. That means you’re out about 5K every year. In other words, the house has to return over 5% a year just to beat the mortgage cost. And that doesn’t even start to add up all the other costs involved. You can cut the interest expense through the mortgage deduction, but that only saves you a few percentage points on the overall mortgage so you’re going backwards from the minute you buy a house.

  15. So, that should say you’re out about 60K every year minus the deduction which reduces that by about 33% roughly. So, no a 100K house the mortgage alone is setting you back 4% per year. Account for inflation and housing is definitely a depreciating asset.

  16. But in the case of a primary residence, which is what I am trying to pencil out in the example above, you must pay to live somewhere. I know for a fact in my area the cost to rent was HIGHER than the cost to buy the “same” type of residence over the last 1-2 years (this has reversed now as prices are screaming higher…which scares the h$ll out of me because it is not sustainable). So the “cost” of the mortgage, including insurance, etc. is a cost that has to be paid in order to live somewhere. Additionally, per your comment, if there is inflation then the cost of rentals would increase every year, while the cost of the mortgage would stay static, making a purchase more attractive over the long term.

    My position is that if done properly RE may very well be an excellent investment…just like every other investment, timing is critical…I am struggling with the broad brush approach that classifies it as poor. That said, I know I am biased since I recently bought a house to live in and turned my former primary residence into a rental.

  17. To see if real estate is a good investment, you have to consider it from an investment perspective, i.e. you purchase a property and rent it out. The total return has to include rental income, just like you have to include dividends in stocks’ total returns. If you can generate 5% rental income, which I don’t think it unreasonably high, you can achieve a real return of 5% assuming your property value appreciates at the same rate as inflation.

    That’s not a bad investment!

    If you use mortgage, your return should be a little higher because leverage is involved.

    You can’t just use price appreciation of real estate to judge whether it’s a good investment.

  18. Yes, as I stated I acknowledge this is an example of leverage, and it impoacts both positive and negative returns.

    Alos, I don’t agree that if leverage is used in a transaction it means you are not “investing”.


  19. Agree, RE can be your residence, in which case price appreciation may be a primary driver of the “return”, or rented out with a revenue stream as the primary driver of the “return”. My position is RE CAN be a VERY good investment, but like any other investment timing is important.

    Maybe I am splitting hairs and missing the big picture becasue I am biased…

  20. Leverage blew up the banking system, because the banks didn’t factor in the potential for dramatic losses. So by all means, invest in your home, but look at both sides, not just the side in which your house goes up every year.

  21. Hans,

    Thanks for the input – I agree, lots of homes purchased outright with cash so little in the way of “traditional” closing costs. I would bet, however, many of those transactions had other costs like rehab.

    That said, when those “owners” choose to liquidate (to “realize” their gains) there will be transaction fees, most likely in the form of commissiosn. Of course, if your organization agrees to sell 300 homes through RE agency X, I am confident you can negotiate a very nice fee structure from that organization! But I am not Blackstone, so more looking at this from an individual’s pespective.

    Also, if the 1/3 figure is right, is it probable that 66% of the total transactions have purchase details much closer to what I sketched out above considering the much tighter lending standards today?

  22. I would phrase buying a house as USUALLY being a better EXPENSE on living. But I would never describe renting or buying a home as an “investment” in the same sense that starting a company is an investment. The real, real returns on renting are terrible obviously. But the real, real returns on buying are slightly better. In either case though, it ends up being mostly something you consume (an expense) and not an investment. Though housing is a slightly better “investment” than renting because you have the direct access to the land value.

  23. Yeah, but most people don’t buy and rent out a house. I think it’s better to look at them both as expenses and conclude which one is a better expense (renting or buying).

  24. But if you compare investments, you have to treat real estate as an investment. Or if you live in a house yourself, then you should consider how much equivalent rent you are saving and include that in your return calculation. Otherwise, it’s not fair to compare real estate price returns to total returns of stocks and bonds as an investment. If I have $100k to invest, I need to look at total returns among the investment options I have, whether I buy a house or stocks.

  25. After taking a second look at your reply, I think you mis-understood my comments. When I say renting, I mean you buy a house and rent it out to tenants as a landlord, not you rent a house and live there yourself. That’s not an investment.

  26. I think it’s best to look at housing as two components, the land (which tends to be an appreciating asset) and the house (which is ultimately a deprecating asset [entropy wins eventually] [in the short term the house deprecates just like a car, in the medium term it depends on the labor and material cost changes, and in the long term it deprecates]). While land can be recycled (as is evident in inner city and top located suburbs “scrapes”) it is costly. In general, as the population increases, land used for housing consumes a real resource, and so the real value of land appreciates. Although wage inflation provides some upper bound on housing inflation in general, most other expenses (except importantly health care) have been declining as a share of income, and so consuming more housing is possible.

    The other thing that is true for housing is that real estate is local. In aggregate it may reflect the US economy, but it also reflects the local economy. The current demand on the SF Peninsula for very modest homes in the $1 million – $1.5 million range means many have multiple offers within a week or so, and the moderate houses in the $1.5 to $2.5 million range are in extremely short supply. These are high prices relative to much of the US driven by the local economy (and the 1 dimensional geography of the SF Peninsula). In the Denver-Boulder corridor construction and sales are rapid in the $400 K – $600 K range, but demand well above a million is not substantial. In Detroit, I expect, these numbers all appear quite large.

    Housing as an investment is basically making a bet on the prospects for the local economy. In a sense this is not that different than analyzing a business or business sector, as opposed to the entire market.

  27. NAE – I’m with you. I get where Cullen is coming from, but I also think it is a bit disingenuous to not take into account that you are coming out of pocket to live somewhere. If you’re monthly cost is the same, and one ends up with you owning a home free and clear after 30 years, and the other leaves you with nothing, how is the former not an “investment”?

    To put a sharper point on my difference with Cullen here – by not considering a home purchase an investment, you are far more likely to make a bad decision. Treat it as an investment (not to be confused with speculation) and you’re less likely to buy when you should be renting, or buying unwisely in some other way. And if it weren’t an investment, why would anyone be saying “don’t buy now, its a bubble” or “I’m constructive on housing now”??? No one says “I’m constructive” on eating at a restaurant tonight, or on paying my phone bill.

  28. please strike “disingenuous” from my comment. i’m coming off as insulting and don’t intend to be. sorry Cullen

  29. What do you see as the difference between an investment and speculation? I’m curious.