Avoid These Costly House Price Assumptions

Avoid These Costly House Price Assumptions
Prices in certain areas are going up, up, up

Avoid These Costly House Price Assumptions

Justin Lavelle
March 24, 2015

By now everyone should be aware that house prices don’t always move rationally, and in some cases can move very irrationally to the detriment of new home owners.

In fact, according to recent data, more than 10% of all US homes with a mortgage are still “underwater” (i.e. have negative equity) as a result of the after effects of the financial crisis that occurred more than five years ago.

While very few people, including the financial experts, foresaw the housing crisis and appreciated the complex effects it would have on homeowners across the country, there are some basic steps you can take as a potential home buyer to limit your risk in making what is likely the most important purchase decision of your life.

While DIY tools now allow shoppers to compare historical home prices, tax information and piece together neighborhood trends, it’s important not to view this type of data in a vacuum, nor make overly rosy projections based solely on historical data.

That’s the message of a new paper by the National Bureau of Economic Research, which looked at house price dynamics that led up to “bubble” situations such as in the immediate run up to the 2008 financial crisis. While the paper is fairly technical, there are a few recommendations you can apply from it which may help inform your own research and strategy for buying a new home:

1. Historical price increases do not necessarily reflect current demand

Shopping for a new home and seeing dramatic recent increases in prices may tell you it’s time to buy before prices rise even higher. Unfortunately, a decision like that could also lead you to buying in at the height of a bubble. Past home prices don’t tell you about the current fundamentals of your area’s market. Overlooking this fact is a mistake many new homebuyers made in the mid-2000s.

2. Be Wary of Multiple Big Price Increases Within Short Periods of Time

This could be a sign that prices in your city or state are becoming disjointed from market fundamentals. Before you splash down that premium, consider consulting with a professional who may have a better idea of the market’s supply and demand dynamics, which are equally as important as price trends.

3. Home prices keep rising—until they don’t

As simple as this axiom sounds, many people forgot it in the mid-2000s and compounded their errors with small or no down payments on homes they couldn’t really afford. The odds of another synchronized national housing crisis of the likes of 2008 is thankfully fairly small, but mini-bubbles can pop up in certain cities, counties or even neighborhoods.

Today, prices in metropolitan areas like San Francisco, New York and Washington DC are breaking all previous local records. Whether these are “bubbles” or an accurate long-term reflection of future demand is not for us to say, but does likely warrant further investigation before making a purchase.

Use data on historical home prices as one tool of many when making a decision on a property purchase. Consider your needs for the property, time horizon and other factors before pulling the trigger, particularly in areas where home prices have risen substantially in short periods of time.

Disclaimer: The above is solely intended for informational purposes and in no way constitutes legal advice or specific recommendations.