Lessons of History

As they say, history doesn’t repeat itself, but it does rhyme.  We might be able to make some observations of about major historical events and trends and their effects on real estate prices.

Minimal real estate United States national price data is available before the year 1900.  However, this chart depicts land sales levels during the 1800’s.  There are pronounced sales cycles that reflect periodic government public land sales, bank lending and then real estate speculation.  With the Louisiana Purchase in 1803, the United States had plenty of land to utilize or sell.  Real estate sales levels steadily climbed peaking in 1836, corresponding with a stock market panic around the same time.  This is reminiscent of the 2008 stock market correction and the real estate bubble pop.  The boom and bust attern repeated with the 1849 Gold Rush, money supply expansion and consequent bank loans and a sales peak in 1854.  Smaller sales peaks occurred in 1869, as the county got back on its feet after the Civil War.  Subsequent booms and busts reflect also reflect stock market conditions, with sales becoming smaller with less land available for sale.

The graph below summarizes the history of single-family home prices from the year 1900 to 2010.  This data was derived by economist Robert Schiller.  Because of industrialization and mass production of housing components, prices dropped in the pre-World War I era.  In World War I, the United States had about 100,000 deaths and 200,000 wounded soldiers.   Although small by European standards, this population decrease had some negative effect.  A larger factor was the 1918 Spanish Flu epidemic in which 50 to 75 million people died worldwide.  In the U.S. about 500,000 to 650,000 died.  During the war years, there fewer young people available to purchase homes resources were directed to war uses.  After the war and epidemic, by about 1920, there was pent-up demand for housing and a consequent increase in home prices.

Housing prices declined in 1929 and 1930 along with stocks in the stock market crash.  Surprisingly, during the Depression prices rose as the economy stabilized and resources were directed toward the necessity of having shelter.  World War II saw a decrease in prices because of less family formation and a focus of investment in the war effort.

Post-War pent-up demand for starting families more than offset the losses.  The famous Baby Boom generated the largest historic increase in demand for real estate.  Additionally, the government provided low interest, no down-payment mortgages to returning soldiers purchasing homes.  Low interest rate loans would become an even larger factor in subsequent booms.  The post war era saw the beginning of suburban home tract developments.  In 1947, Levittown, New York was the first large scale development with several thousand detached single-family residences constructed in assembly-line fashion.  Rectangular 800 square foot (74 square meter) homes  with white picket fences, green lawns, modern kitchens with appliances were constructed first here and then all over the country.

Home prices were relatively stable during the 1950’s, 1960’s and early 1970’s.  This was a period of relative stability of interest rates and bank lending practices.  During the late 1970’s home prices increased during a period of economic stagnation.  During this time of high inflation and increasing interest rates, banks were stuck with low interest fixed rate loans.  Owners had fixed low payments with rising rents, and a consequent economic gain.  With inflation and interest rates  peaking at around 15% in 1980, the real estate market eventually collapsed.  Starting in the late 1980’s and early 1990’s another boom and bust cycle developed.  This cycle was correlated to a growing economy and an eventual recession.

The largest of the real estate bubbles was a combination of many factors.  The market bottomed in the late 1990’s and reflected the booming economic times.  After the stock market correction and the 911 attacks, the Federal Reserve Bank accelerated its low interest rate policy.  At this point in time, interest rates have nowhere to go but up.  Additionally, lenders loosened lending requirements and bundled loans into securities for sale.  Therefore, banks did not retain the liability of the risky loans that they sold into the bond market.

Added to the problem is distortion of the data.  Inflation calculations have been modified over the years so as to understate the rate.   The definition of the Consumer Price Index has been modified over the years.  A basket of typical consumer goods in the past might have included steak, but now has cheaper chicken substituted.  This process goes on with a variety of goods such as computers, which seem to go down in price in terms of the power of computing.  When the inflation rate is under-estimated, then the growth rate of the economy is consequently overstated.

Risks to the value of real estate in the future include a potential reduction of the mortgage interest rate deduction.  A portion of the value of real estate is the tax deduction.  Other key government policies include government support of the Federal Housing Administration subsidies allowing for low income loans and low down-payments.  If these and other government supports are removed because of budget cuts, a large portion of real estate demand is removed.

On the other hand, because citizens consider real estate important, there is strong resistance to any changes that will have an adverse impact.  Additionally, real estate is a hard asset that endures and can possibly thrive in an inflationary environment.  Because of the complexity and risks of our economic system, my philosophy is:  don’t extend yourself beyond your ability to pay back a loan, pay off your debts, diversify into a variety of assets, and have cash available for opportunities.