Housing Market Price Trends

Using data provided by the Office of Federal Housing Enterprise Oversight (www.ofheo.gov), I took a look today at U.S. housing prices over the past 30 years. My objective is to try to understand the price behavior of real estate in my area (Seattle metro), relative to property in other geographical areas, in hopes of gaining insight into future price trends.

I downloaded the OFHEO index data into a spreadsheet, calculated year-on-year housing price changes, and graphed the resulting time series for the U.S., the Pacific region (CA, OR, WA), Washington state, and the Seattle metropolitan area. Unfortunately, I do not know how to insert my graphs into this blog; so, I'll just summarize my observations:

1. There is a strong correlation in price movement between all geographical segments.

2. The smaller the geographical segment, the greater the volatility: Seattle is more volatile than WA, WA more volatile than both CA and the Pacific region, and the Pacific region more volatile than the U.S. as a whole. (Comment: Price volatility and liquidity seem to go together--the higher the liquidity (e.g., real estate in large cities, or publicly listed stocks), the higher the volatility.)

3. Within the Pacific region, price movement in CA tends to "lead" WA and OR by about 6 to 9 months. This behavior is particularly evident in periods of rapid double-digit percentage price appreciation. (Comment: This is a "ripple" effect, with price trends beginning in highly populated areas and working their way outwards into surrounding areas.)

4. Currently, we appear to be in the middle of a two- to three-year period of accelerated double-digit percentage price appreciation, this time around being driven by low interest rates and a recovering economy. Similar periods of rapid price appreciation occurred most recently in 1977-1979 and 1988-1990:

(Table shows range of year-on-year price appreciation)

Period: U.S., Pacific Region

1976-1980: 7 to 15%, 14 to 26%
1980-1985: 2 to 7%, 0 to 11%
1986-1990: 0 to 9%, 3 to 21%
1991-1995: 1 to 4%, -3 to 3%
1996-2000: 2 to 8%, 0 to 11%
2001-2004: 7 to 13%, 8 to 23%

5. During the past 10-, 20- and 30-year periods (all looking back from end-2004), average annual price appreciation has been:

Segment: Average Annual Price Change Over 10 yrs., 20 yrs., 30 yrs.

U.S.: 6.1%, 5.2%, 6.0%
Pacific region: 8.0%, 6.8%, 8.1%
CA: 9.1%, 7.2%, 8.6%
OR: 5.8%, 6.3%, 6.4%
WA: 5.4%, 6.0%, 7.1%
Seattle: 6.3%, 6.5%, 7.7%

Generally, higher price appreciation has corresponded to higher population growth: The growth rate in the Pacific region is higher than the U.S. average, CA higher than WA and OR, and Seattle higher than the WA state average.

For comparision, I also provide a quick summary of historical stock market returns. Annual total return figures for the S&P 500 have been 9.0% over the past 10 years and 10.1% over the past 20 years. I do not have equivalent total return figures for real estate, but I believe that equity returns for stock and real estate investments with comparable risk-reward profiles should be similar over long periods of time. Using our 10- and 20-year numbers as benchmarks for comparison of these two markets:

Stock market total return
= Stock price appreciation + Dividends
= 9 to 10%

Real estate total return
= Property price appreciation + Cash flow
= 5 to 7% + Cash flow,

"Equity return equivalence" implies that operating cash flow from real estate (houses) might be expected to be around 3 to 4% per year, which is approximately the cap rate for an unleveraged investment in single-family homes. (Leverage complicates matters; however, the multiplicative effect that leverage has on equity price appreciation is approximately offset by decreased cash flow from interest payments and on debt.)

The conclusions I draw from this brief analysis are:

1. Short term: Real estate in Washington state (in particular, the Seattle metro) appears poised to continue a double-digit percentage price run-up over the next year or so, in the wake of California's 25% move (versus just 10% for Washington state) in 2004.

2. Medium term: Sometime over the next few years housing price appreciation will likely cool back down to the single-digit year-on-year percentage growth range, and prices could even drop slightly if the current market becomes speculative or the run-up prolonged.

3. Long term: Real estate prices tend to be "sticky upwards" and less volatile than stocks, with upward price momentum often continuing for years and corrections being mild. Over the long run, equity investments, whether in real estate or the stock market, should generally be expected to produce similar total returns.

In other words, it's late but probably not too late to catch a healthy chunk of the current wave. Secondary markets (e.g., WA and OR) are likely a better bet at this stage than "primary mover" markets such as California.