WHAT HAPPENS TO HOME PRICES WHEN INFLATION RISES?

What happens to home prices when Inflation rises?

This has been a question on my mind for a long time. Unfortunately I did not have a great resource for accessing this information until a very good friend of mine invited me to a special presentation by Randy Rowe , President of Green Courte Partners. Mr. Rowe’s presentation to a select group of the Steamboat Springs real estate community was focused on what current economic indicators were telling us vs. the opinions. During this presentation, the main question swirling in my mind was, “If the United States is about to enter an inflationary environment, leading to higher asset values, further leading to higher interest rates, what is the long term effect on residential real estate prices?” Fortunately, Mr. Rowe had access to this data and provided me with the following chart:




This chart compares the OFHEO home price index and the 30-year, fixed-rate mortgage from 1975 (the first year the OHFEO home price index was produced) through 1981 (rising rate environment), and 1981 through December 1995 (declining interest rate environment). WOW, exactly what I was looking for. Take a look at this chart for a moment and there should be a few questions that pop into your head.

1. Rising rates should cause a decrease in a buyer’s purchasing power, therefore capping or cause a decrease in the price index. Why don’t we see this?
2. I thought during the early 90’s we there was a very bad real estate market where home values dropped precipitously. Why is this not shown?

These were my first thoughts, obviously prompting me to ask my curious questions. It appears there must be other economic variables during rising rate environments that offset the lost buying power (of course I want to know what that is and will be a future chart/blog if I can get the information). Also, during the early 90’s, the commercial real estate market took a far greater hit than residential. There most likely were local market retracements in value, but across the broad index residential values remained somewhat stable.

What does this mean for today’s buyers of real estate? No one knows for sure, so all you can do is take action based on the most likely scenario or the scenario that presents the least amount of risk. It is a fact that real estate values have declined significantly from their highs, correcting by as much as 50% in some markets. If it is assumed that going forward we will resume a more normal appreciation, buying real estate that you wish to own for personal use looks like a much better idea than in 2006/2007. Just due to an increasing population, decreased residential construction and depressed values, you can make the case that buying today makes sense. The other big variable is interest rates. Looking at the chart above, it is clear that a 5% 30-year mortgage is way below the historical average. Locking in long term rates today may prove to be a very prudent decision (possibly the best decision of all mentioned above).

If this creates any questions, please email or call me. I’ll enjoy finding the answers.