Mortgage Rates, House Prices, and Inflation

One of the first things to understand when looking at an asset is what drives long-term returns. While people say for RE it’s location, location, location, at a macro level it’s location, inflation, and mortgage rates.

This graph shows you the famous Case-Shiller index (blue line). It’s an index of nominal prices for housing. It’s up 241% over the last 3 decades.

I then make two adjustments. The first is I adjust for the fact that mortgage rates have gone from 10% to 3% over this period. I calculate how much house prices would be rates stayed the same.That is the grey line. You can see after that adjustment, house prices are only up 81%.

I then adjust for inflation by using the CPI index as well as rates (red line).

As you can see, the entire increase in house prices the last 30+ years can be explained by inflation and mortgage rates. About 2/3 of the price change is due to mortgage rates going down and 1/3 inflation.

Thus, future prices will depend on those two things as well. I’m not sure rates can go much lower, which will be a drag on price increases in the future.

More Money, No Houses

I still get the most questions about what is going to happen to the residential real estate market. As I have stated since March, it’s going to be OK. Here’s another reason why: You can afford 12% More house today because of rates.

Here’s a graph of 30-year mortgage rates. I’ve then graphed how much of a house you could afford relative to a $500,000 house a year ago.

As you can see, instead of a $500,000 house, you could get a $565,000 house today.

You main problem? There is nothing to buy. Many markets have almost no inventory available.

Yes. The last recession housing prices crashed. This is not the last recession. Housing is going to be strong given low rates and no inventory.