Fintech executive, writer, math geek, and investment systems developer. Founder and CEO of Altruist and Founder of FormulaFolios.

Is Now a Good Time to Buy Real Estate?

Is Now a Good Time to Buy Real Estate?

I recently had a blog reader pose a question I hadn't gotten in awhile, and thought others might have the same one.  Basically, they wondered if now was a good time to buy real estate, or if a stock market correction would create a better buying opportunity.  Here's the full question:

Do you have any charts that illustrate a correlation between the stock market trends and home price trends, as well as home supply trends? I know real estate is a local matter but I am practicing patience while waiting for the stock market to drop to buy a house, assuming home prices will drop too in response. Am I right to assume there is a correlation?

I wrote back, but this also got me thinking.  Here's how I replied:

The stock market and real estate market are not usually very correlated. So if the stock market drops, that likely will not have a whole lot to do with housing prices. The last real estate drop was more to do with prices getting pushed artificially high because it was too easy for buyers to get loans. As a result, there were a lot more buyers than homes available, so prices rose. When getting financing became nearly impossible, prices dropped (on homes traditionally financed) considerably.

At the moment, interest rates are very low, and financing is generally quite easy. It’s not as easy as it was a few years ago, but it is compared to the last 50+ years. I suspect the next trigger for a housing price drop will be when loan costs rise. This will happen when interest rates go up, but irrespective of what’s happening in the stock market.

A nice point of reference is looking at home prices relative to interest rates the past 30 years. Back in the early 1980′s a mortgage generally came with interest rates in the mid-teens (12-18%). As a result, prices had to be low because the monthly payments were quite high relative to what was typically borrowed. Today, with historically low interest rates, a rather large mortgage is still affordable to a lot of buyers. But…when rates rise, prices will have to come down (unless wages go up substantially).

So if you’re looking for a good time to buy, be sure to save your cash, and be a cash buyer when interest rates are 2-5% higher than they are today. I suspect that will happen in the next 2-5 years, and when it does, home prices will need to drop 20% or more to maintain equitable mortgage cost for buyers.

Now I wrote this reply without first doing any research.  It was just my calculated opinion.  However, be the ever OCD math geek, I decided to do a little data collection and see if my point was valid.

WARNING: This post contains math geekery that may be offensive to some readers.

WARNING: This post contains math geekery that may be offensive to some readers.

How to Determine if it's a "Good Time to Buy" Real Estate

The first thing I wanted to know was how real estate has increased in value of the past 50+ years.  Unfortunately, there are no real numbers on the average prices of real estate going back much further than 25 years, so my test had to start in 1987 (the start of standardized indexes that track national home values).  Yes, there are other data sources, but I prefer using independent data sources, not Realtor data sources (they're a bit biased ;)).

Using data from the Case Schiller 10 City Composite from 1987 to 2013 I built the following chart:

Case Schiller Composite 10 Price History. Source: Standard & Poors

Case Schiller Composite 10 Price History. Source: Standard & Poors

As you can see, prices have clearly been on the rise when taking the long view, but are still quite a ways from the all-time highs of 2006.

The next thing I wanted to validate was how interest rates correlated with prices.  For that I built another chart with a second axis, and built a simple trend line for both prices and interest rates.  I used the National Average 30 Year Fixed Rate Mortgage as my interest rate proxy.

This chart is below:

Real Estate Prices Relative to Interest Rates

Real Estate Prices Relative to Interest Rates

Yikes!!!  As you can very clearly see, prices go up in near perfect unison with interest rates dropping.

However, the Devil is in the Details...

One thing that jumps out to me when looking at the charts, is how low prices are today relative to the long term trendline.  This is similar to home prices in the mid 1990's, which was the pre-cursor to the huge increases in real estate values for the next 10 years.  Real Estate supporters might point to this detail and suggest that prices still have a long way to climb, therefore you should buy before it's too late!

However, for history to repeat itself, we'd also need interest rates to behave like they did during the same time period.  That, is hard for me to swallow.

You see, in January of 1996 the Case Schiller Index was at 76.82 and 30 year fixed mortgages were at 8.83%.  By January of 2006, the Case Schiller Index was at 222.46 and 30 year mortgages were at 6.15%.  This represents a 190% increase in home values, with a 30% drop in interest rates.

For this same time period to repeat itself, we'd be looking at home prices tripling by 2024 and interest rates close to 2% on a 30 year fixed rate mortgage.  Possible?  Yes.  Likely?  I sincerely doubt it.

So What's the Bottom Line?  Is Now a Good Time to Buy or Not?

I think in the short term real estate is an interesting opportunity.  Prices are still low around most of the US, and interest rates are very low.  Getting a mortgage is much easier today than it was 2 years ago.  Just looking at the charts for a few minutes tells me that so long as rates stay low for the next few years, prices should go up.

Longer term though, I think there could be some issues.  And it all depends on interest rates.

Consider what happens to buying power IF interest rates go up just 1% or 2%:

$100,000 mortgage at 3.5% interest $449.04 per month

$100,000 mortgage at 4.5% interest $506.69 per month

$100,00 mortgage at 5.5% interest $567.79

These might seem like small numbers, and that's because they are.  In most parts of the US you can't buy much for $100,000.  At least no place I'd want to live.  Double the numbers above and you can start to see where parity comes into play.

With 2% higher interest rates the monthly payment alone goes up 26%.  Rates could rise that much in just a few years, but most people's incomes will not.  Therein lies parity rules.

To me, parity rules means that home prices need to drop to match wage inflation.  So if over 5 years the cost of buying a home (on a monthly basis, as most new home sales are purchased) rises 26%, and wages only increase 10%, prices of the homes need to drop to create parity in purchasing power.

For simplicity, we'll just assume simple interest - so prices would need to drop in order to create a mortgage payment just 10% higher than what can be bought today.  How does that work?  Like this.

$100,000 mortgage at 3.5% today $449.04 payment today

$449.04 mortgage payment today, adjusted for 10% higher income = $493.94 payment parity

5.5% mortgage amount for a $493.94 monthly payment = $86,995 mortgage

If we see mortgage rates go back up to the 7%+ range - watch out!  Home prices could very well tumble.

To put this as simply as I can: If interest rates go up 2%, and wages only go up 10%, then home prices would have to drop about 13%.  Regardless of inflation.

There are a bunch of other factors and correlations I could calculate; rent relative to mortgage cost, population growth relative to new home supply, etc, etc.  They all can factor into the economics of home values.  But for my dollar, when it comes to buying a single family home and getting a good price, the thing that scares me more than anything is rising interest rates.  In some markets (high end cash buyer markets) it might not matter, but for most of America it will.

I should also clarify that investment property (rental income), I think now is a reasonable time to buy.  Prices are still fairly low, rents are steady and mostly rising, cost of borrowing money is cheap, and it's one of the few remaining great tax benefits available in the US [not giving tax advice, always consult with a properly licensed tax professional to determine if any investment provides tax benefits to you].  If interest rates rise, and homes become more expensive to purchase, rental properties will be in great demand.  For full disclosure, this is the only type of real estate I'm buying personally.

For even more full disclosure, I'm NOT suggesting anyone go out and buy rental properties!  This blog is informational only, and I would never make a recommendation without fully understanding a readers goals, risk tolerance, and a whole slew of other information necessary to provide financial advice.  Always be careful whenever considering any financial advice, and always consider the source.

In a Nutshell, prices could/can go up some in the next few years.  Or they might not.  It all depends on interest rates.  If they stay low and incomes increase - that's very positive for real estate.  If rates start to rise, but incomes stay relatively flat - that's very negative for real estate.

If you're considering buying as a long term property you'll live in personally, then it probably doesn't matter a whole lot.  If you're looking at a property as an investment you may want to sell in the next 5-10 years, I suggest you be very careful.

Hope this post helps a lot of people.  If you have an opinion you'd like to share, or data that might be useful for readers of this post, be sure to use the "comments" section a couple inches below this post:).


Jason Wenk

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