Housing Price Simulation

Okay, so here's the premise of the computer simulation. Take 65% of the BLS average weekly wages and apply them to the cost of basic home ownership. I have assumed that 1.5% of the price of the home is needed to pay property taxes, insurance, and miscellaneous per year. The rest is used to pay principal and interest on a 30-year conventional mortgage. This is a "what do you want your payments to be" simulation, since that is the society we seem to live in.

If two people are working, that works out to about 1/3rd of all income. How did I come up with that number? It simply did a good job of helping the model match reality (in other words, the red line most closely matches the black line in the chart below).



Note that there are two reasons that housing prices have increased over the years as far as the model is concerned. First, wages rose thanks to inflation. That meant that people could afford higher monthly payments. Second, interest rates have been dropping for decades. That allowed people to afford more expensive homes.



The following shows what happens when it is adjusted for inflation. From 1982 to present the computer model expected inflation adjusted prices to rise substantially due to falling interest rates, and they did.



So what went wrong? The computer model suggests we should be doing pretty good right now, but we're clearly not.

It is a "what do you want your payments to be" problem. Since housing prices were rising faster than overall inflation, housing prices were also rising faster than the cost to build the homes. Thanks to capitalism, that meant that more and more homes would be built. Eventually, there were just too many homes and everyone started to realize it. Oops! At that point, it stopped being a "what do you want your payments to be" problem and became a "how do I unload my home before it tanks to its true value" problem, or should have been anyway.

You will also note that the model expected falling prices in the 1970s, since interest rates were skyrocketing (and homes were therefore less affordable). That didn't happen either. People were scared of inflation and were buying up hard assets. It wasn't a "what do you want your payments to be" problem in my opinion. It was a "what do you want to spend your money on before it is worthless" problem. Using hindsight, 1979 was a bad time to be buying a home though (just like 1989 and 2006).

That's one way to look at the data, but here's a few more ways. The blue dot represents where we are now.



We have an unemployment problem right now. If people don't have jobs, then it certainly makes it harder to afford a new house. My simplistic computer model above cares nothing of unemployment and/or excess housing inventory though. Perhaps it could get a job at the National Association of Realtors? ;)



We also have low interest rates though. That should help in theory. However, as seen in the following chart something doesn't quite seem right.



Low interest rates AND high unemployment? Why am I in this "blue" hand basket and where am I headed? Japan?

Based on what I see here, stagflation does not appear to be imminent. May it never arrive. As a saver, I'd be just fine with that. On the other hand, we're clearly not out of the deflationary woods yet nor am I expecting a huge rebound in America's growth engine.

I turned bearish in 2004 based on the idea we were trying to borrow our way back to prosperity. I grow more permabearish with each passing year and/or with each passing trillion dollars of new debt. Oh sure, we'll probably get a recovery of some sort just like we did the last time. I certainly wouldn't bet against it. Where will we be in 10 more years though? Exiting the woods or burning them to heat our homes?

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Source Data:
Census: Median Home Prices (PDF)
St. Louis Fed: CPI-U
St. Louis Fed: Employment & Population
FRB: Selected Interest Rates