What The Future Holds for Home Prices

U.S. home prices rose in June from a year earlier for the first time in nearly two years, according to data released Tuesday. Is this the start of a bounce back for housing, or is it just a cheerful blip in the numbers before prices resume their fall?

Bet on neither. Instead, assume for planning purposes that U.S. house prices will rise by an average of 2.3% a year over the next decade. Here's why: House pricestend to track the rate of inflation over long time periods (see chart). After all, inflation is the gradual rise in the cost of ordinary goods and services, and houses are boxes made from ordinary goods and services -- lumber, copper, carpentry and so on.

If house prices either outpaced or lagged behind the inflation rate over long time periods, houseswould become either infinitely unaffordable or cheap. Of course, that doesn't happen. Booms and busts tend to offset each other, leaving house prices in sync with other prices. That's what has happened over the past dozen years or so.

Predicting the inflation rate is difficult, but the work is already done. That's because of a special kind of bond called Treasury inflation-protected securities, or TIPS. These give investors both a stated interest rate and an ongoing principal adjustment based on the consumer price index, the main measure of inflation. Regular Treasurys give investors only the stated yield.

The difference between TIPS yields and regular Treasury yields, then, is equal to investors' collective bet on the rate of inflation. Right now, that spread is 2.3 percentage points on 10-year issues.

Investors should assume that rate for the next 10 years of annual inflation -- and house price gains.

Housing bears will point out that the recent year-over-year price gain is just 0.5%. All of it may be due to a recent drop in mortgage rates luring buyers, which isn't likely to repeat. And last year made for an easy price comparison, because prices dropped following the expiration of housing stimulus programs. Indeed, house prices may already be falling again. The latest Case-Shiller reading is for June, and really, it reflects purchases that were inked a few months prior.

Housing bulls counter that mortgage delinquencies are down, new home sales are up and affordability has been restored.

They each make good points -- and their views are already reflected in market prices for houses, which is why prospective buyers should ignore them. They should also ignore broker claims about a particular area being an up-and-coming one or a deep value. Those sentiments are priced in too.
Buyers should instead use their 2.3% house gain forecast in one of those renting-versus-buying calculators available. Good ones typically ask the user to plug in forecasts for their annual rent increases, annual house price increases and the rate of inflation. Use the same number for each (2.3% or whatever the current spread between TIPS and regular Treasury yields suggests).

Of course, house prices may not exactly track inflation over the next 10 years. They could rise more or less, and history suggests price gains will vary sharply by market. Even in the same market, some buyers will get better deals than others. But the point of the forecast is to base housing decisions on a sober look at likely outcomes rather than hope or hype.

Homeownership still looks like a good deal in most markets, but that has little to do with June's price rise or the possibility of timing the market.