Interest Rates, Inflation and Home Prices

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Submitted by XBoxBoy on May 28, 2021 - 9:57am

I've been thinking about the question of how much recent price rises are due to work from home narratives, people moving from other areas, and how much is due to record low interest rates. To answer this, I decided to make some charts that would show what I could reasonably expect to happen when interest rates change.

This first graph shows the relationship between interest rates and the size of a loan with a set monthly payment. To create this graph I used $2,500 a month payment. (Which might seem low for San Diego, but the amount of the monthly payment isn't important, a larger payment simply moves the graph up.) I did not include taxes or mortgage insurance, or consider down payment. All examples I'm using are for 30 yr. fixed. The goal here is to just show how much more you can afford as rates change.

Rate-Varied-Chart

Two simple take-aways from this chart: 1) The obvious, that as interest rates go down you can afford a lot higher purchase price and 2) as interest rates go down the curve gets steeper and so prices increase more due to a .5 percent drop from 3 to 2.5 than from a .5 percent drop from 8 to 7.5.

Next, I wanted to add some historical perspective to this. Interest rates have changed a lot over the years, so how much of the change in home prices is due to change in interest rates? Here's a graph that shows, given a monthly payment combined with the 30 yr. rate at a given time, what would be the purchase price you could afford. (Again, ignoring taxes, insurance, & down payment)

For this chart, I'm using a monthly payment of $2500, a starting date of January 1987 and mortgage rate data from FRED. I am not taking into account points paid. I'm not sure how important that is or isn't.

Historical-Rate-Chart

Now, the problem with the previous chart is that it assumes that over time the monthly payment people could afford wouldn't change. But over time inflation should cause wages to increase, thus increasing what people feel they can pay monthly. So, I've added a bit of code that increases the monthly payment by the inflation rate. Here's the chart with a starting monthly payment of $2500 and every month I adjust that amount for inflation.

Historical-Rate-And-Inflation-Chart

Note the above does not deal with the issue of location at all. The above merely looks at the impacts of interest rate changes and inflation on expected home price. These charts are not unique to San Diego, or any sub-area.(Which brings up a bunch of interesting questions about what has happened in areas where home prices haven't risen over the years!)

But now, let's introduce some data to see how the expected home price compares to actual home prices. To do this, we can use the Case Shiller Index. I'll calculate the initial price based on what could be afforded on January 1, 1987 and then using San Diego Case Shiller Index, plot the Case Shiller price over the years.

Historical-Rate-And-Inflation-Case-Shiller-Chart

In the above chart you can clearly see the housing bubble of the early 2000's! (And note, the above chart uses San Diego Case Shiller, not national Case Shiller)

One last point, the above charts are all linear in both the x and y. But arguably the y (price) should be shown as a log scale. So here's the final chart showing my interest rate and inflation adjusted expected price and the Case Shiller price with a log scale for the y.

Historical-Rate-And-Inflation-Case-Shiller-Log-Chart

So what to make of the above charts? First I think it'll be really interesting to see how different people will interpret the charts differently and to see how people use the charts to argue differing points.

But for me, the biggest observation is that most if not all of the home price increases we've seen in San Diego are the result of interest rate changes and inflation. This isn't a commonly held view, and one I would have doubted before doing these charts. The narrative that the home prices increases over the years are because so many people want to move here and that demand has grown while supply of houses hasn't, just doesn't hold up when I look at these charts.

The other thing is, if home prices increases are so strongly correlated to interest rates and inflation, what would happen if interest rates were to start rising? I'm not saying that's going to happen but it's worth keeping an eye on.

Sources of data:

Interest rate:
http://www.freddiemac.com/pmms/pmms30.html

Inflation data:
https://www.usinflationcalculator.com/in...

Case Shiller San Diego:
https://fred.stlouisfed.org/graph/?id=SD...,

Submitted by an on May 28, 2021 - 10:28am.

You forget the key factor about RE (location, location, location). Not all area of RE increase at the same rate or decrease at the same rate. Also, not everyone's salary increase at the same rate. Not everyone can afford/buy a home, so instead of looking at overall inflation, maybe you should look at wage inflation for the top 20%. Here's an article about the migration pattern over the last year:
https://candysdirt.com/2021/05/19/pandem...

Submitted by XBoxBoy on May 28, 2021 - 11:12am.

an wrote:
You forget the key factor about RE (location, location, location). Not all area of RE increase at the same rate or decrease at the same rate.

Actually, I haven't forgotten this at all. My post isn't meant to address anything about any specific location. In the last two charts I do compare expected house prices with Case Shiller for San Diego, but I don't attempt to address anything more specific than San Diego in general.

Quote:
Also, not everyone's salary increase at the same rate. Not everyone can afford/buy a home, so instead of looking at overall inflation, maybe you should look at wage inflation for the top 20%.

I'm not sure why we would want to limit to just the top 20% unless you are arguing they are the only ones who buy houses in San Diego. But, yes, using wage inflation instead of general inflation would be an improvement. I just didn't find wage inflation data so instead used general inflation as a proxy. I'm assuming that over the course of 35 years the two remain reasonably correlated. Maybe I'm wrong about that though.
Quote:
Here's an article about the migration pattern over the last year:
https://candysdirt.com/2021/05/19/pandemic-sparks-a-rebound-in-residential-migration-survey-finds/

Overall, I think you're missing what I'm saying in my post. While I initially set out to try and answer how much of recent price changes are due to issues like people moving from out of town versus interest rates, what I ended up showing is that over the last 34 years almost all the rise in home prices in San Diego can be attributed to interest rate changes and inflation. Because my charts show 34 years of data, only a very small part of the charts are specific to the current situation. And the part that is for the last year is for San Diego overall, not a specific area.

But the bigger take away for me is that if I am correct that home price increases are largely correlated to interest rates and inflation, that means a lot of the narratives told in the past about why home prices are going up were false. Which leads me to be rather skeptical of the narratives I'm hearing now.

Submitted by an on May 28, 2021 - 11:27am.

XBoxBoy wrote:
Overall, I think you're missing what I'm saying in my post. While I initially set out to try and answer how much of recent price changes are due to issues like people moving from out of town versus interest rates, what I ended up showing is that over the last 34 years almost all the rise in home prices in San Diego can be attributed to interest rate changes and inflation. Because my charts show 34 years of data, only a very small part of the charts are specific to the current situation. And the part that is for the last year is for San Diego overall, not a specific area.

But the bigger take away for me is that if I am correct that home price increases are largely correlated to interest rates and inflation, that means a lot of the narratives told in the past about why home prices are going up were false. Which leads me to be rather skeptical of the narratives I'm hearing now.


I understand what you're trying to say. But I think you put more weight and correlation to rates than inflation. That's what I'm trying to convey, is that wage inflation is probably a better correlation than rates.

This is why I'm trying to convey about the top 20% income inflation. 20% is some random number I pull from the sky, but the point is that someone making minimum wage would not be buying houses. They're renters.

Submitted by XBoxBoy on May 28, 2021 - 11:40am.

an wrote:
But I think you put more weight and correlation to rates than inflation. That's what I'm trying to convey, is that wage inflation is probably a better correlation than rates.

I'm not claiming any more weight or correlation to rates than inflation. I'm claiming that rates combined with inflation are the principle drivers of house price increases.

And I agree that wage inflation would be more appropriate than general inflation, and can see your point that low wage earners can probably be ignored. But I also doubt that there would be much difference in the charts. Maybe someone like Rich has wage inflation data we could use?

Submitted by sdrealtor on May 28, 2021 - 11:55am.

Nice work but so tough to simplify something impacted by so many factors. Rising rates would only lock more people with sub 3% in place and further limit supply. On the demand side I would agree that inflation and rates were huge but don't discount stocks, wealth transfers, stock based comp plans, work from home, higher awareness of SD worldwide, transforming from a tourist/military economy to tech/telcom/life science economy locally and of course crypto baby! They are all supercharging each other and I left out plenty Of others. In the current boom down payments have been huge on the whole which limits impact of wages and rates. There is no simple answer

Submitted by Rich Toscano on May 28, 2021 - 11:57am.

xboxboy, this is awesome! Thanks for putting it together.

I've got to get on a meeting soon so very quick thoughts:

First, the steepening curve where as interest rates get lower, they exert a continually higher impact on affordability - that is something I had never thought about. That could be an important piece of the puzzle. I'd always observed that in the past, interest rates didn't have such a big influence on valuations, but they seemed to have more of an impact more recently. This might be a result of the non-linear impact of rates -- they didn't matter so much when they were higher in the past, but matter a lot more now. Must think about it more.

Second, if you are inclined, I'd love to see a variation on the final graph that, instead of mapping both series, just shows the % difference between each series. That would give a more fine-grained look at how over- or under-valued SD housing is compared to your indicator.

Third, I'd be curious to see -- what happens to the price model if rates go up to X? I guess I can do the math on that one based on the first chart. But for one example -- rates got to the mid-4s in 2018. What would happen to your price model if they went to 4.5% again?

BTW I do have data that I'd be happy to share. To spare everyone the details on that, why don't you PM me or email at rich@piggington.com.

Submitted by an on May 28, 2021 - 12:12pm.

XBoxBoy wrote:
I'm not claiming any more weight or correlation to rates than inflation. I'm claiming that rates combined with inflation are the principle drivers of house price increases.

And I agree that wage inflation would be more appropriate than general inflation, and can see your point that low wage earners can probably be ignored. But I also doubt that there would be much difference in the charts. Maybe someone like Rich has wage inflation data we could use?


The reason why I think you're put more weight on the rate than inflation because you assume price increase because rate goes down. In the 70s, rates went up and price went up as well. Maybe, if you have data as far back as 1970, you can use the same chart to see if your hypothesis still apply in a rising rate scenario.

Submitted by XBoxBoy on May 28, 2021 - 12:41pm.

sdrealtor wrote:
Nice work but so tough to simplify something impacted by so many factors.

Actually, I don't feel I'm trying to simplify. When I first set out to do this, I thought, maybe interest rates and inflation would account for about 50% of the rise in prices. I didn't for one second think I would find that interest rates and inflation would account for pretty much all of the rise. When the charts first popped up, I was shocked how close they were. And then when I started to think about what I was seeing I realized that none of these other factors probably matters much at all. (At least not over the long term. Over the short term, we can see the actual prices (red case shiller) deviates from my expected prices during the mid-2000's. So over the short term, prices can definitely be impacted by other factors!)

Quote:
Rising rates would only lock more people with sub 3% in place and further limit supply.
Don't misunderstand me here. I'm not making any prediction about what will happen. Not only would what you say potentially be true, but if interest rates do go up, there's a good chance that they are going up because of higher inflation at the same time. Depending on the amount of inflation we could see very different paths.

Quote:
On the demand side I would agree that inflation and rates were huge but don't discount stocks, wealth transfers, stock based comp plans, work from home, higher awareness of SD worldwide, transforming from a tourist/military economy to tech/telcom/life science economy locally and of course crypto baby! They are all supercharging each other and I left out plenty Of others. In the current boom down payments have been huge on the whole which limits impact of wages and rates. There is no simple answer

If we are talking short term (5 years?) maybe some of those factors will have a large impact. But looking back historically, it doesn't look to me like any of those things have had a long term impact. I will certainly concede though that past performance is not indicative of future performance, so... who knows maybe in the future.

Submitted by XBoxBoy on May 28, 2021 - 1:15pm.

Rich Toscano wrote:
First, the steepening curve where as interest rates get lower, they exert a continually higher impact on affordability - that is something I had never thought about. That could be an important piece of the puzzle. I'd always observed that in the past, interest rates didn't have such a big influence on valuations, but they seemed to have more of an impact more recently. This might be a result of the non-linear impact of rates -- they didn't matter so much when they were higher in the past, but matter a lot more now. Must think about it more.

So mostly for amusement here's the chart that shows what you could buy with interest rates from -10% to 20%.

Rate-Varued-Chart-10-To20

This gives you a sense of just how unlinear the curve is. But if you think about it, realistically home loan rates are not likely to go into negative territory and even 10 and above seems extremely unlikely any time soon. So, we are only really interested in the 2-5% range which is comparatively flat against the overall curve.

Submitted by XBoxBoy on May 28, 2021 - 1:32pm.

Rich Toscano wrote:
Second, if you are inclined, I'd love to see a variation on the final graph that, instead of mapping both series, just shows the % difference between each series. That would give a more fine-grained look at how over- or under-valued SD housing is compared to your indicator.

Here it is:

Deviation

Most notably you can see the big overvaluation that was the 2006 bubble. It looks like currently we are overvalued but not significantly.

Submitted by sdrealtor on May 28, 2021 - 2:11pm.

Correlation is not the same thing as causation

Submitted by The-Shoveler on May 28, 2021 - 2:19pm.

IMO can't discount the sugar high,

In the mid 80's mortgage rates were in the 10's housing was going up 15-20% a year in LA (defense spending boom sugar high).

Submitted by deadzone on May 28, 2021 - 3:44pm.

XBoxBoy wrote:

But the bigger take away for me is that if I am correct that home price increases are largely correlated to interest rates and inflation, that means a lot of the narratives told in the past about why home prices are going up were false. Which leads me to be rather skeptical of the narratives I'm hearing now.

Yes, this pretty well debunks the non-sense narrative from the real estate crowd that "everyone wants to move to San Diego" blah blah blah.

The interest rate is key for multiple reasons. Yes obviously it pushes peoples ability to make mortgage payments. But in the bigger picture, it is this low interest rate environment that has enabled so many people to get wealthy in the first place. One example is through their corporate stock options and other pay packages that are killing it thanks to the fact that corporations have been borrowing money at near 0 rates and using it to buy back shares. All of this is induced by Fed easy money policies.

Submitted by sdrealtor on May 28, 2021 - 4:36pm.

It does nothing of the sort

Submitted by XBoxBoy on May 28, 2021 - 4:49pm.

sdrealtor wrote:
Correlation is not the same thing as causation

True. However in this case I feel there is probably a causality at play. Feel free to disagree though.

Submitted by XBoxBoy on May 28, 2021 - 4:50pm.

The-Shoveler wrote:
IMO can't discount the sugar high,

In the mid 80's mortgage rates were in the 10's housing was going up 15-20% a year in LA (defense spending boom sugar high).

Undoubtedly we have had a number of sugar highs in the past, and probably will have more in the future. The problem with the sugar high though is that they don't last.

Submitted by sdrealtor on May 28, 2021 - 4:57pm.

XBoxBoy wrote:
sdrealtor wrote:
Correlation is not the same thing as causation

True. However in this case I feel there is probably a causality at play. Feel free to disagree though.

OK Let me amend that. 100% correlation is not 100% direct causation. There that’s better

Submitted by Reality on May 28, 2021 - 10:08pm.

With inventory as low as it is is it possible San Diego is actually undervalued when interest rates and inflation explain most of the price difference from the past? What would prices have looked like 30 years ago with such scarce supply?

Submitted by svelte on May 29, 2021 - 8:23am.

XBoxBoy,

This is a truly impressive piece of work. I love your thought process and how you used that to drive what you research and how you present it.

There is no "but", this work stands on its own and deserves kudos.

It is interesting to see how interest rates and inflation can account for darn near everything we see in San Diego housing prices, as your overlays clearly show. As others have pointed out there are other things that influence prices also, but most years that is in the noise while on rare occasion they truly do need to be factored in.

Again, congratulations. We'll never get house prices down to an exact science because humans are emotional creatures, but it is fascinating to see how you can get into the ballpark by relating a few key facts.

Thank you!

Submitted by sdrealtor on May 29, 2021 - 10:06am.

Interest rates and inflation account for higher cost and price of just about everything everywhere. Devalue the dollar and flood with currency and prices will rise. I don’t think anyone would disagree with that.

For me the question is what explains the rest of it. Why do prices rise more and faster here than Cleveland? Why do single family homes rise more than condos. Why has beach area properties appreciated more than East County?

While he did an excellent job, I think it’s just showing how markets behave in general and I’m always looking for the exceptions that allow one to beat the market. Am I missing something?

Submitted by svelte on May 29, 2021 - 10:53am.

sdrealtor wrote:
Interest rates and inflation account for higher cost and price of just about everything everywhere. Devalue the dollar and flood with currency and prices will rise. I don’t think anyone would disagree with that.

For me the question is what explains the rest of it. Why do prices rise more and faster here than Cleveland? Why do single family homes rise more than condos. Why has beach area properties appreciated more than East County?

While he did an excellent job, I think it’s just showing how markets behave in general and I’m always looking for the exceptions that allow one to beat the market. Am I missing something?

I think the answer to all of your questions in the second paragraph boil down to one word: desirability. SD is more desirable than Cleveland (where the term "sunshine tax" came from), SFR are more desirable that condos, and beach property is more desirable that desert. Not sure there is much mystery in that. The question you may really be asking is how does one calculate how much more something is worth given that it is more desirable.

I'm not willing to pay more to live at the beach as I would probably hate it there (traffic, moisture, etc), but I'm willing to pay more to not live in the desert which is why I live about 11 miles from the coast. And I'm definitely willing to pay more for a SFR than a condo...a little more privacy is worth something to me, though I don't need so much privacy that I need to move to the desert! :-)

Submitted by Rich Toscano on May 29, 2021 - 12:13pm.

I’ve been thinking about your results in the context of my monthly payment chart:

My interpretation of this chart has always been that it shows that rates haven't had a ton of influence on home valuations. If they had, then the red line would mean revert around a pretty flat line across the whole chart. In other words, monthly payments would be the constraint, and home prices/valuations would move up or down to accommodate a pretty constant monthly payment (as a % of income).

But that's definitely not happening in this chart. In the 70s and 80s, valuations didn't plummet to accommodate high rates. Instead, prices hung in there, and people paid a much higher monthly payment (as a % of incomes or rents).

Thus my conclusion that you can't really value housing based off rates.

However, if you take a closer look at my graph, there are really 2 regimes there. In the 70s/80s, home prices weren't influenced so much by rates. However, starting in the 90s, we DO see that more flat trend line where (with the exception of the bubble), monthly payments tended to stick to a somewhat constant level.

And that fits in perfectly with your conclusions -- prices really have followed rates pretty closely. But if we were to extend your study back in time, we'd find that this wasn't nearly so much the case.

What do we make of this? Well, it happens that this is actually a fairly controversial topic in finance generally.
One camp claims that lower rates justify higher stock valuations, pointing back to 30-40 years of a clear correlation there. The other camp points out that prior to that period, there was no such correlation! (Here is an article exploring some of the long term data). There are other arguments as well, such as: if low rates are such a benefit, why are stock valuations in Europe and Japan much lower than the US, while their rates are ALSO lower? IE, it seems that this relationship has only taken place in the US, which undermines the idea of a causal relationship.

So I just wanted to put that out as a note of caution here. xbox's analysis happened to cover the period where there was an unusually strong relationship between rates and the prices of RE and risk assets generally. But, this relationship is not written in stone.

Now, let's say the relationship does remain intact. xbox's results jibe with my general view that even through prices look high, when you consider interest rates, they aren't nearly so bad.

However, based on these charts I've refined my view a bit. Looking at my monthly payment charts, I was thinking, we're still below the historical (post-1977) median. But that includes the prior regime. If we only look at the 90s+ regime, with that tight relationship between rates and prices, then we ARE in fact overvalued even considering how low rates are. xbox's charts do a good job of showing that. But, it's a reasonable level of valuation, part of the normal ebb and flow, and nothing I'd consider remotely bubble-like. (Of course I mean overvalued based on this model... there are of course things going on outside the model, eg long term supply and demand changes, which could impact fair value.)

The other thing to consider is that if the rate/price relationship remains intact, this doesn't tell you much about future prices anyway, UNLESS you want to posit that you know what rates are going to be. It's my view that rates (and inflation, which heavily influence nominal rates) are poorly understood, and that the world's most preeminent economists and asset managers disagree on what the course of rates will be. IE, I don't think anyone can really make a high confidence forecast on rates. So IF the rate/price relationship remains intact, it is a fact that any home price forecast has an embedded interest rate forecast.

Submitted by sdrealtor on May 29, 2021 - 12:17pm.

Exactly where I was going. Desirability but there’s no way to measure that so one must relie on anecdotes. That something cannot be measured does not mean it’s not a vital part of the equation and should be dismissed

Submitted by svelte on May 29, 2021 - 12:36pm.

"Mortgage/tax payment on SD single family home divided by equal-weighted SD rent and per-capita income"

Appears to mean (SD SFR mortgage payment / SD SFR tax payment) / (SD rent payment + per-capita income).

Or does it mean
(SD SDR Mortgage + tax payment) / (SD rent payment + per-capita income)

I'm not sure how that correlates to XBoxBoy's data on house prices. I guess you could argue that house prices correlate to mortgage payments, but I'm not sure that's true. And what any of that has to do with rent or income I'm not sure.

Submitted by Rich Toscano on May 29, 2021 - 12:42pm.

svelte wrote:
"Mortgage/tax payment on SD single family home divided by equal-weighted SD rent and per-capita income"

Appears to mean (SD SFR mortgage payment / SD SFR tax payment) / (SD rent payment + per-capita income).

Or does it mean
(SD SDR Mortgage + tax payment) / (SD rent payment + per-capita income)

I'm not sure how that correlates to XBoxBoy's data on house prices. I guess you could argue that house prices correlate to mortgage payments, but I'm not sure that's true. And what any of that has to do with rent or income I'm not sure.

It's the latter. It correlates because it's measuring monthly payments vs. "inflation" (xbox was using CPI, I use wages and rents) so should come up with similar results.

Submitted by XBoxBoy on May 29, 2021 - 3:33pm.

sdrealtor wrote:
For me the question is what explains the rest of it. Why do prices rise more and faster here than Cleveland? Why do single family homes rise more than condos. Why has beach area properties appreciated more than East County?

While he did an excellent job, I think it’s just showing how markets behave in general and I’m always looking for the exceptions that allow one to beat the market. Am I missing something?

It's important to keep in mind that the above charts and data do not answer most the questions you are asking. These charts and data are really only about the cause of the rise in house prices over the last 30 some years in a broad area. (San Diego in this case) And as you have pointed out previously, that relationship might not be causal.

Additionally, this data and charts do not explain any of the deviations from the expected price such as the housing bubble we saw in early 2000's. So, clearly the relationship between interest rates, inflation, and house prices doesn't hold true at all times.

I could make some speculative guesses as to why prices didn't rise as fast in Cleveland, and why they rose even faster in Silicon Valley, but without data, they would just be guesses. But in this thread I'm trying to stay within Piggington's motto: "In God we Trust, Everyone Else Bring Data." (Although admittedly I do think that question could be a really interesting discussion. But it probably needs its own thread.)

Submitted by sdrealtor on May 29, 2021 - 3:52pm.

Gotcha and I agree interest rates and inflation are a big influence on home prices. To me it’s like saying water is wet because it’s obvious they influence all asset prices. However there are not the sole cause. There are other significant forces which can’t be so easily measured but none the less are very powerful. I took exception to the inference that inflation and interest rates explained all or nearly all of the price changes.

And I’ve been having that discussion for years but others refuse to acknowledge that which I provide evidence of though not perfect statistical data as it does not exist because it can’t be measured

Submitted by gzz on May 29, 2021 - 4:39pm.

You have some places with expected rent and demand for housing generally expected to decrease over time. That completely changes the PV of housing, especially when rates are low.

This is very good work xbox.

Submitted by XBoxBoy on May 30, 2021 - 3:04pm.

I’ve got some new data from Rich that I want to share, and I’ve been working with the charts and trying to develop some insight into what I’m seeing.

Here’s the same chart as I used above but with data from Jan. 1977 through April 2021.

Fig1

The orange is the CaseShiller price and the blue is the price I would anticipate based on interest rate and inflation. (From here on out I’m going to refer to the anticipated price based on interest rate and inflation as the XValue, just because that’s easier to type.) There are two things to notice before jumping to any conclusions about this chart.

One of the first insights I had when looking at this chart is that the vast majority of the time house prices were overvalued in the last 45 years. Then I realized that this chart assumes that the Case Shiller and XValue are equally valued in January 1977. But the chart has very few times that is true. Simply because my data starts on January 1977 doesn’t mean the Case Shiller and the XValue would be equal at that time. So, let’s take a look at the chart with the Case Shiller undervaluing the XValue by 30% at January 1977.

Fig2

Now we see about an equal amount of overvalue and undervalue.

This also lead me to realize that without some anchor to tell me that houses were fairly priced on a specific date, it becomes very difficult to use these charts to tell if currently (or at any specific time) housing is overpriced or underpriced.

Previously I claimed that over the long term the vast majority of house price rise could be explained by interest rate changes and inflation. (Short term that isn’t so true, but long term it is) Now that I have more data I think that claim still holds up very well. To help see that, I can fit a second order polynomial to each data series to find the slope.

Fig3

Here we see a purple line which is the fit for the Case Shiller, and the yellow line which is a fit for the XValue.

The next issue is that as prices go up, price increase look bigger than they are when measured in percent. Imagine this scenario: You buy two houses, one for $500k and the other for $200k. Twenty years later the first house is worth $1.5m and the second house is worth only $600k. So the first house has appreciated $1m and the second house has appreciated $400k. Which one has a better return? The answer is neither, they both tripled in price. But the higher the starting price the bigger the increase should be numerically. So, when we look at the above chart, the most recent years look like a lot more appreciation but as a percent not so much. To compensate for this it’s important to work with log scale on the charts if you want to talk about growth rates. So, here’s the same chart but with a log scale on the Y axis and no slope lines.

Fig5

And now with the slope lines.

Fig4

Submitted by XBoxBoy on May 30, 2021 - 3:34pm.

Another interesting insight when using data from Jan. 1977 is in this chart. This compares the deviation of the Case Shiller price from the XValue:

Dev1

What I notice in this chart is that in 1980-1983, when interest rates were so high (mid teens!) prices people were paying were way above what we would expect based on the XValue. But we don't think of that time as a bubble, because within a couple years interest rates had started their long march downward, and so people could refinance out of the high rates. Also, during the next few years prices didn't grow much. So, I wouldn't call it a bubble, since it never popped.

Which tells me, that just because prices go way above the XValue, we shouldn't assume we are in a bubble. If it is followed by a period of lowering rates the XValue could increase rather than prices collapse.

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