Housing is Hot: Time to Jump in?

dream houseHouse prices rose 9.3% in the 12 months ended February 2013. So says the Case-Shiller 20-City Composite. This was the highest growth rate since 2006. Some communities are seeing double digit gains; particularly those hardest hit earlier. Phoenix had a 23% twelve-month increase, San Francisco 19%, Las Vegas 18% and Atlanta 17%. Inventories of available homes are dropping- to less than three months supply in some of the hottest markets.

Certainly, the Fed has had a big hand in the recovery. Lower interest rates have made housing comparatively a more attractive asset. And, lower mortgage rates have created urgency for buyers. They want to own a home for many financial reasons, the most important of which, according to a recent Gallup poll is the hope to make a “good investment that appreciates in value.”

Yet, despite the recent run-up in prices, Robert Shiller, co-creator of the Case-Shiller Index, remains cautious about the long-term investment value of houses.

Over the last 100 years, house prices have increased only 0.2% per year, in real terms (after subtracting inflation). Yes, of course, house prices continue to rise. If inflation continues at the current 2.5% rate, a home selling for $400,000 today might sell for around $500,000 in ten years. Even though the price is up, the real value (in terms of purchasing power) is unchanged. Investing in housing is not like investing in stocks. Successful businesses should grow over time and so should their stock prices. Housing, on the other hand, declines over time, unless the owner pays for maintenance and improvements.

Furthermore, Dr. Shiller believes that the Fed’s quantitative easing (“QE”) has produced a “totally artificial real estate economy.” What would happen if 30 year fixed interest rates were 6% instead of 3.5%? Buyers would have their purchasing power reduced significantly. At today’s rates, $1,800 per month would cover principal and interest on a $400,000 mortgage. If rates were 6%, the same $1,800 would only fund a $300,000 mortgage. Assuming that individual had $100,000 as a down payment and rates were 6% instead of 3.5%, they could only afford a $400,000 house instead of one that was $500,000.

In addition, economic and demographic changes may severely impair the value of the house when it is time to sell. In the 19th century, housing was built near factories and warehouses. In the early 20th century, houses were built around streetcar routes. The suburbs started to boom in the 1950s when the Interstate Highway system came. Today, there is a trend toward walk-able urban areas and away from distant suburbs. In addition, aging baby boomers are creating demand for more continuing care retirement communities. So, the value of your house ten or twenty years may be impacted not only by inflation and mortgage interest rates but also whether your house is still fashionable. As Dr. Shiller points out: “Today’s dream house may not be tomorrow’s.”

There are many good reasons to buy a house. Most people live in their house for many years to build equity, receive tax deducations, and to live the American dream. That’s wonderful. Now may be the best time to act and lock in an ultra low mortgage.

However, for those of you considering buying principally because your house will be a “good investment that appreciates in value”, you may want to think again. History and changing economic and demographic conditions aren’t on your side.