Where Are Housing Prices Headed?

HouseOctober 31, 2013

According to most financial pundits and economists, the answer is higher.  They should continue to appreciate since they have only moderately recovered from the post-bubble lows experienced in 2012.  But if these same economic forecasters never saw the previous housing bubble, why should we trust their opinion now?

For example, on July 1, 2005, almost exactly a year before the precipitous decline in housing prices, Federal Reserve Chairman Ben Bernanke was asked on CNBC about the possible repercussions from a collapse in housing prices.  Bernanke responded: “Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis.”

This chart, and the experience of every American, disagrees.

The reason Bernanke and other experts missed the housing bubble is their misplaced belief in Keynesian economic thought.  The backbone of the housing market, much like any financial market, is economics.  Misunderstand what causes recessions, and you miss the housing bubble and its ensuing collapse.  Keynesians do not see anything inherently wrong with aggressively expanding the money supply.

We subscribe to the Austrian school of economics.  Austrians understand that the expansion of the money supply distorts the level and structure of interest rates.  The lower interest rates induced businesses (homebuilders) to make investments (housing developments) which appeared profitable.  But eventually these investments were recognized for what were: unprofitable ventures (for a longer explanation of the Austrian theory of the business cycle, please visit here).  This was the primary cause of the housing bubble and collapse. 

Based on the Austrian theory of recessions and given the actions of the Federal Reserve since 2008, an inflationary recession – akin to the U.S. in the 1970’s – is likely within the next five years.  In light of such a potential economic scenario, where are housing prices headed?  Prices will likely move higher, at least in nominal terms (i.e., not accounting for the effects of inflation).  But perhaps a more relevant question is: Are housing prices affordable?  They are not, and they are likely to become less affordable.

Affordability is largely a function of household income and interest rates.  Those who think housing will become more affordable must believe interest rates will continue their historically low levels and unemployment will not rise.  An inflationary recession will prove both wrong.

What should one do if they believe housing prices will rise despite decreased affordability?  Two actions may make sense.  First, refinance with the largest fixed-rate mortgage possible.  Second, consider an investment in apartment complexes.  With falling affordability, developing well-placed and reasonably priced apartments which mimic the look and feel of a single-family home should do well.  WindRock has an excellent vehicle for such an investment.