Is Homeownership A Good Hedge Against Inflation?

How home prices compare with inflation over time

If you have been watching the news, you know inflation has been running very high for more than a year. This means we now pay more for gasoline and groceries, we're paying more for cars, and of course, we're paying more for houses too.

When I turned 30 in 1995, the average home price in the US was $112K. 27 years later, the average home price on my birthday was $389K, an increase of 247% (4.7% annualized growth). Lately, home prices have pushed higher faster than any time I've seen over those 27 years, and I'm reading and hearing concerns from people about home affordability.

If you saw my recent article about home prices, you know that buying power dropped 40% from December 2021 to June 2022, so this is an epic home affordability erosion issue that homebuyers face today. Can you imagine being told you can now spend 40% less than you planned on a home while home prices grew by 10%?

This is terrible news for homebuyers, yet there is more than meets the eye. Could buying a home today still be a smart hedge against inflation? After all, it's not just the costs of (everything) being inflated, wages are inflating too. Is today a logical time to rent a home, or should one consider buying one to win the battle against inflation?

Home Prices Versus Inflation And Equity

We know that the 130-year trend for home prices tells us that homes go up in value at a fairly consistent rate. There are periods when home prices fall, but most of the time, home prices rise. There were only 3 times home prices fell (nationally) over the past 100 years (the Great Depression, World War II, and the Great Recession).

The Reason Why Homeownership Beats Inflation

In this graph, we compare home price growth and equity growth with inflation. The US Home Price Index is plotted in gray and has risen 348% since 1987. The Consumer Price Index (inflation) is plotted in blue and has risen 153% during the same period. But here is the big kicker.

Sure, home prices have beaten inflation, but there have been times when that wasn't true. Right now might be one of those times, but we won't know until we look back at the modified data. But none of that matters. Most people don't pay cash for homes, so we don't compare home prices with inflation to see which is prevailing. Instead, we look at "leveraged appreciation."

One great benefit of owning real estate is that we get to realize gains from a property appreciating without having to put 100% cash down to own it. If somebody wants to realize the gains from $400K worth of Amazon stock, they would need to invest $400K. But to realize the gains from a $400K home, most owner-occupants can do that with an investment of $40K or even less. They are "leveraging" $40K to reap the benefits of a $400K asset.

The red line in the graph plots equity growth from somebody buying a median-priced home in 1987, investing just 10% for the down payment and closing costs. While the home price index has soared, the equity gain blows it away. The equity growth of 3477% since 1987 represents an annualized gain of just under 10%. Leveraged appreciation is the reason that homeownership is an excellent hedge against inflation.

But what about the chaos in the market? Have prices soared so high that they must come down? Many people believe this will occur.

If you are somebody who has to move, maybe you are changing jobs, changing cities, having a major family change, whatever, what do you do? You can rent, but rents are soaring now too. You can buy, but home prices have risen more than 25% in the past few years.

To help you evaluate your situation, and have assembled data from the past to help you apply it for today.

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Buying A Home Versus Renting In Troubling Times

The most-vocal concern I hear about housing today is that our situation is "just like 2006." Though I have produced numerous articles and videos showing that today's housing market is in a very bad place, it is not in the same situation as we saw in 2006. There are some parallels, though. The housing market was very active, and home prices increased aggressively in both periods. But today, we have an inventory shortage, whereas in 2006, inventory was plentiful and growing.

To help you make a "buy vs. rent" decision today, I have produced the following graph that evaluates your cash positions for deciding to rent or buy a home today. For our regular readers, you have seen this graph in a different case study comparing buying a home versus renting a home.

Graph plots the outcome of buying versus renting a home in 2006

With so many people thinking the market will soon see plummeting home prices (like we saw in 2006), I have used historical data to show that if one could go back in time to 2006 and face a decision on whether to buy or rent, the answer would be determined by the length of stay in the home.

No answer is right for everybody (nor wrong for everybody). Instead, one must evaluate their own situation and react accordingly. Again, I want to remind the reader this is an analysis designed for somebody who must make a move today due to a significant life event.

The graph above plots the cash position of buyers in blue and renters in red. The cash position is merely the combination of what has been spent with equity gained, so renters continue to decline over time while owners, through leverage appreciation, have the ability to move above "zero."

As a reminder, home prices peaked in 2006, so people who purchased in 2006 faced six straight years of declining home prices. It was the worst time to buy a home in the past eighty years. Before we get to the analysis, I want to pre-comment to those who think buying a home when prices are falling is a terrible mistake. Remember, I have twice reminded the reader that this buy-rent analysis is for people who HAVE TO MOVE. Buying might be painful, but renting is not free either. This analysis helps somebody facing this decision to have a good idea of what to do.

People who stayed in their homes longer than 3.75 years spent less money than those who chose to rent. Home prices were dropping, and rents were rising, so homeowners faced the worse housing market conditions in eighty years while renters faced fairly normal conditions. Either way, renters and buyers were out tens of thousands of dollars. It was so bad that buyers who sold their homes after 5 years had to bring cash to closing when they sold. Everybody selling at that time faced hardship, yet the money required to sell their homes (combined with everything else they spent) was less than they would have paid in rent.

If you are renting and think you'll be relocating to another market in the next few years, you should continue to rent. You'll need to be prepared for huge increases when your lease renewals come around, as rents are soaring right now due to the limited supply of housing. There is a non-recoverable cost to rent, but it likely is less expensive than buying and then selling in a short time period (as the graph above reveals).

But if you know you're going to need to move (move up, move down, or move over), today's "bad time to buy" will deliver a better outcome for you than entering into a lease (unless you can get a landlord to sign a long-term lease with minimal escalations each year). The housing market in most local US metropolitan areas is grossly undersupplied with adequate housing for our growing population, so we know the long-term trend is continued rent and price increases, though we'll see some opposing trends along the way as the Fed increases rates to bring down inflation.

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