Everyone has an opinion about where home prices are heading. Many of them are optimistic, which is exciting – but don’t run out and start throwing money at real estate just yet. Much of this optimism is based on nothing more than hope. Rather than think wishfully, let’s explore some data and see what is reasonable for US Home prices.
How NOT to Analyze Data
An often cited measure of US Home Prices is the Case-Shiller Home Price Index. This index tracks how the average home price increases or decreases over time. The absolute number isn’t meaningful, but the change from year to year is.
This chart shows that index from January 2000.
I’ve heard some experts take this data and argue something along these lines:
In the chart above, we see that starting in 2007 we had a large drop in home prices and we’re now beginning recover. We can expect a more than 17% increase in home prices in the near future to recoup our losses.
The Purchase Anchor Fallacy
One trap that everyone, including myself, falls into is what I like to call the Purchase Anchor Fallacy. When we purchase something, we create a psychological, and illogical, attachment to that price. When new information challenges this price level, we try and explain it away.
For example: say you buy a stock for $30. The market sells off and the now it’s trading at $25. Do you sell it? Assuming minimal transaction costs, you should keep the stock if you would buy it again at $25. Today’s price is today’s price and your decision should have nothing to do with historical prices.
That said, as humans …read more