Real Estate Prices Always Go Up, Right?

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It seems like common knowledge, like the sun will rise tomorrow, like a law of physics. Real estate prices can only go up, right?


“The land price myth” (Tochi-shinwa) as Japanese economists would put it, refers to the high degree of confidence that real estate prices will continue to rise over a long period of time. I was sold on this idea as well, up until very recently. Why not? Land is finite and demand continues to increase due to population growth.


As soon as I asked myself the question “what could cause real estate to decline?”, I started to learn about a variety of variables that could play a part in causing real estate prices to decline. I also learned that throughout history, real estate values have only increased by about 2% per year over the long term. I believe the 2% figure is inflation adjusted, read “Irrational Exuberance” by Robert Shiller for reference to the exact figures from his study on the subject.


At the time of writing this(4 qtr 2017), not only are we faced with the fallacy of the land price myth, but also the supply of houses is barely keeping up with demand. Which would suggest prices should move higher. In our local market homes are selling on average within 28 days of being listed. Listed homes are supplying only provide about 3 mo worth of house sales, also the number of homes being listed are trending downward. New home construction is barely making any headway, due in part to lack of available land and a labor shortage. Sounds great right? Why would home prices decline in a market where supply continues to be a problem?


Basic information about this area; median income 50k per year, wage growth over the last 17 yrs has been about 10k on average, median home price is currently about 219k, very difficult to find anything under 150k, and the population is expanding.


We know that there seems to be supply constraints, but what about demand constraints? If we look at the average household income of 50k per year, assume they pay about 15% in taxes that leaves them with 42.5k per year or $4,166 per month after taxes. If we use a conservative number and assume a household can support house payments that are 25% of his take home pay, we get about $885 per month that the average household can spend on paying for a mortgage. A home loan for 175k, with current interest rates on a 30 year loan at 4.1%, would be $846 per month. Add taxes, home owners insurance, and possible HOA fees and we go slightly over our $885 per month home cost.


Based on these figures, the average household in this market cannot support the average house price. As I mentioned before, very few houses are available for under 150k. Homes for sale in the 150k to 175k are relatively few and far between as well. So this leaves the average household with a few options; wait, pay more than you can afford, or compete for the small supply of homes in the price range. This doesn’t even begin to address the below average household income.


I believe given this data it makes the case that current real estate prices cannot go much higher, at least in our local market.


Now this brings up the next question, why are real estate prices already above what the local market can support? The answer I have for this is purely speculation, since I have not taken time yet to fully research the answer. But, my theory is that relative to other asset classes, investment in real estate makes sense. I believe this has attracted investors from outside the local market and driven up prices. If this is true in our market, how many other markets across the nation are experiencing similar circumstances?


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