The Real Story Behind Home Prices: Separating Fact From Fiction

The Real Story Behind Home Prices: Separating Fact From Fiction

When it comes to buying a home, many misconceptions about the housing market can cause confusion and uncertainty for potential homebuyers.

One of the most persistent myths is that home prices fall frequently, so buying a home is risky. However, this is simply not true.

In this article, we'll use the "Myth-Busting" framework to debunk a widespread misconception. We'll present historical data to support our argument and show you the truth about how home prices change. Get ready to have your mind blown!

Debunking A Stale Housing Myth

Myth: Home prices fall frequently, making buying a home a risky investment.

Fact: Home prices can fluctuate over time, but they do not fall frequently. Historical data shows that home prices have steadily increased over the long term.

To support this claim, let's look at the historical median home price in the United States.

US Median Home Price

When we examine the past sixty years, it is clear that home prices generally rise. This graph plots the median US home price for the past sixty years and identifies the five times home prices fell with red stars.

Graph reveals five times in the past 50 years when the median US home price declined

According to data from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, the median home price in the United States in 1963 was $17,200. By 2018, the median home price had risen to $322,800, an increase of over 1,777%. While there have been occasional dips in home prices, such as during the housing crisis in 2008, these are relatively rare occurrences in the long term.

It is also important to note that even during times of economic downturn, such as the Great Recession of 2008, home prices eventually recover. In fact, by the end of 2022, the median home price in the United States had exceeded its pre-recession peak by 82%.

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The Data Is Clear, So Why Does This Myth Endure?

So why does the myth persist that home prices fall frequently? One reason may be that we tend to remember negative news more than positive news. When we hear about a housing market crash, it can create a lasting impression that home prices are always at risk of falling. However, as we have seen, this is not the case over the long term.

I believe the primary reason that people are expecting home prices to crash is due to recency bias.

Recency bias is a cognitive bias that refers to the tendency of people to place greater importance on recent events than on past events. When it comes to the housing market, recency bias can lead people to believe that another market crash is imminent because they vividly remember the housing market crash of 2008.

During the Great Recession of 2008, the housing market experienced a significant downturn, with home prices plummeting and many homeowners facing foreclosure. This event had a profound impact on the economy and people's finances. As a result, the memory of the 2008 housing market crash is still fresh in people's minds, and it has led to a sense of caution and anxiety among potential homebuyers.

The problem with this recency bias is that it can lead people to make decisions based on their fears rather than on the actual state of the housing market. While it is true that the housing market suffered a rare, multiple-year downtown in 2008, people must remember it was the first time since the beginning of World War II that such an event occurred. In fact, we have to go back to the Great Depression to find a downturn that matched the Great Recession.

A simple case study that includes recent "bad years" is enough to put this myth to bed.

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Case Study: Buying A Home Before A Downturn

According to data from the National Association of Realtors, the median tenure for homeownership in the United States was ten years as of 2021. We've used this "holding period" to examine the outcomes of buying a home before the five home price declines of the past sixty years.

The previous graph showed five median home-price declines in the US since 1963. To answer the question, "should you buy or lease a home if you expect home prices to fall," we have created a case study that uses historical data on home prices and mortgage interest rates to assess the estimated cash position of a tenant and a buyer making a housing decision in December for each of the years prior to home prices falling.

When home prices are expected to drop, do you buy or do you rent?

To answer this question, we created an Excel spreadsheet with five separate amortization tables to calculate the financial position of both tenants and buyers for each of the five periods where home prices fell. Though this process does not precisely replicate the cash position of either tenants or buyers, it does a fair and equal job of analyzing each position.

For example, we did not calculate the amount buyers might spend on maintenance, but we also used below-market rents with no rate hikes during the entire ten-year rental period. In the end, the cash position of both tenants and buyers would likely be a bit lower than what this shows, though equally distributed and thus providing a fair analysis.

The cash flow for buyers is shown in blue, while the cash flow for tenants is shown in red. In each of the five years preceding home values falling, it was financially a wiser move to buy than rent. Remember, these are possibly the worst times to buy in the past 60 years, but with ten years of ownership, it was still far better financially to buy than to rent.

The graph shows that whether you buy a home or rent a home, it comes at a cost. But thanks to the benefit of leveraged appreciation, the cost of owning is far lower than that of renting, and in our five-scenario case study, the cost of owning was 48% cheaper than the cost of renting.

Time Mitigates Real Estate Risks

This case study demonstrates that if you have enough time (in this case, ten years of ownership), then it has ALWAYS been better (financially) to buy a home than it has been to rent. But that does not mean that "everybody should buy a home."

There are numerous reasons why somebody could wisely choose to rent versus buy:

  • First and foremost is the uncertainty of how long you plan to be in the area. If you plan to relocate to another market in the next year or two, renting is the safer choice.
  • Second, In some markets, you might be able to rent a far nicer place than you can afford to buy. Home affordability is tanking; thus, renting might become the norm for all but the wealthiest among us.
  • Finally, if you travel often and don't want the additional responsibilities that homeownership requires, you too could wisely choose to rent.

In conclusion, if you have the luxury of time and prioritize making a financially sound decision, then purchasing a home is likely the best option, provided you can find a suitable property within your budget.

Don't be deterred by negative opinions on social media; renting may be unnecessary when homeownership is a viable means of protecting your finances against inflation and has been a successful route to wealth for many Americans in the past six decades.

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