The Ultimate Guide to Home Price Appreciation

View the video of this post here.

Your home is your castle, and if you’re like most Americans, it is also the single largest component of your net worth.

Naturally, you would love to see your home appreciate in value over time. But by how much – what’s a reasonable expectation?

To answer that question, let’s take a look back at history…

Since 1891, U.S. home prices have increased 3.4% per year before inflation (“nominal”) and 0.5% after inflation (“real”).

Over long periods of time, there’s been a high correlation between changes in overall inflation (CPI) and changes in home prices, with the two variables generally moving in tandem.

Before 2000, we had never seen U.S. home prices outpace inflation by more than 30% on a cumulative basis (since 1891). Few considered their primary residence to be “an investment” in a similar way to stocks or commercial real estate.

But that thinking completely changed during the housing bubble of the early-to-mid 2000s when home prices exceeded U.S. inflation by an unprecedented margin (95% by the end of 2005). This led many to believe that houses were not only investments, but a better one than stocks because they “never went down.”

And then, of course, prices went down. From 2007 through 2011, U.S. home prices fell every single year, declining a total of 26% on a nominal basis and 35% on an inflation-adjusted basis.

But the story doesn’t end there.

Fueled by a desire to create a so-called “wealth effect,” the Federal Reserve attempted to boost the value of housing and other assets, holding interest rates at 0% for a record seven years (from December 2008 to December 2015) and purchasing a record amount of bonds to artificially suppress interest rates. At the same time, the U.S. Government created a homebuyer tax credit (2008-10) and borrowed trillions of dollars, sending three rounds of stimulus checks (2020-21) to most Americans.

As a result, we saw a second U.S. housing bubble take hold. Home prices more than doubled in the 10-year period from 2012 through 2021, and have recently surged to a new record of 118% above inflation.

When mortgage rates spiked higher in 2022, the median home for sale in the U.S. quickly became even less affordable than the previous bubble, and the demand for housing collapsed.

But prices did not come down as supply collapsed even more, only exacerbating the affordability picture. The median American household would now need to spend a record 47% of their income to afford the median priced home for sale.

And the median household income necessary to purchase the median home for sale in the US ($124k) is 57% higher than the current median household income ($79k). Needless to say, this is an untenable situation, but how and when this enormous gap will be closed remains to be seen.

What does the history of home price appreciation tell us about the future?

In the short run, not very much.

Why?

Because there are a multitude of factors that can impact the housing market, including: affordability, inflation, economic/wage growth, the availability of credit, mortgage rates, unemployment rates, new construction rates, demographics/population growth, sentiment (fear/greed), and Federal Reserve/Government policy. Collectively, these factors dictate supply and demand, which in turn determines market prices.

Differences in these variables can lead to vast differences in appreciation rates from one year or one decade to the next and from one city to the next. One example of this: over the last five years, Miami home prices have increased by over 80% while San Francisco prices have increased by 34%.

On a national basis, U.S. home prices have increased over 53% in the past five years, more than double the increase in average wages.

This has created extremely high expectations about future gains because of “recency bias,” our tendency to project in into the future what has happened in the most recent past.

But given that the rate of appreciation over the last five years is more than 3x higher than the historical median for a five-year period (+17%), the recent past is not a good representation of what will happen in the future.

Which is to say that the first half of the 2020s decade, with annualized home price appreciation of 8.8% before inflation and 4.6% after inflation, is unlikely to repeated in the back half. There is no rational justification for prices to continue to outpace inflation by such a wide margin.

In fact, one could make a strong case that over the long run prices should not outpace inflation at all, and that the only reason why real prices are higher today than 100 years ago is due to the fact that houses today are much larger (138% increase in median square footage from 1920 to 2020).

So what should homeowners expect going forward?

A much more modest pace of growth at roughly the local rate of inflation, with the understanding that it could very well be less if we see any reversion to the mean.

For when housing prices deviate too much from the rate of inflation, there’s a natural correcting mechanism in that supply eventually increases (more homes are built) and/or demand eventually decreases (fewer people buy homes as they become less affordable). This is intuitive, for homes should ultimately be priced based on the cost to build/maintain them and your ability to afford them (wages), which are both reflected as part of the inflation rate.

Up until now, we’ve only focused on home prices, but the price of a home doesn’t include the many other costs associated with home ownership (mortgage interest, taxes, insurance, closing expenses, repairs, maintenance, capital improvements, etc.). If you’re evaluating a home as “an investment,” a true rate of return would need to include these costs as well, making the analysis much more complicated.

Which is why buying a home to live in should be viewed very differently than passive investments like stocks and bonds. Your home is your castle and should provide benefits to you and your family beyond just the numbers. Price appreciation is only one small part of the equation.

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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.

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