Residential Real Estate: Making Sense of Madness

The Following Is From The Finance Professor

For years, inner city real estate was overvalued worldwide. Real estate for top-tier cities like London, Hong Kong and New York traded between 12 & 20 times annual average earnings, putting homeownership out of bounds for many residents. Then Covid triggered real estate insanity away from the urban centers. Aging populations, downsizing and moving towards the convenience of inner city flats began to reverse course and looked to get away from inner-city & high-rise crowds. Low interest rates were extra fuel on the real estate fire.

A quick look at a very nice Tampa Florida property listed on Redfin shows the current and past reality of real estate ownership (14802 Dunstan Place, Tampa FL 33618):

For decades, the value of this house did nothing. At best, the appreciation stayed in-line with inflation. The first three purchases didn't work out at all for the buyers. Even the buyer who held for 12 years lagged inflation. Primary residences are not investments. Rather, they are intelligent consumption. Remember, real estate depreciates, which is why the IRS allows for depreciation of investment property. Because primary residences are consumption, the IRS does not recognize the depreciation, but, believe me, depreciation is real. My best estimate is that property depreciates about 0.5% a year and that, on average, the land is 20% of the value and the structure is 80% of the value. So, you have 80% of the value depreciating at -0.5% yearly and the land appreciating in line with inflation, which is about 6% per year. House prices rise faster than that because you have to add back the annual spend at Home Depot - people fix up their houses so they don't depreciate. A quick look at the long-term chart of money supply growth vs. inflation shows that since 1995, inflation has been around 2%-to-3% and the money supply growth (i.e. the real inflation) has been 6% or 7%. Don't believe the government inflation statistics, they are not indicative of anything real.

Maybe most important in the housing equation is the housing shortage and the lack of properties available for sale. Here is a chart of houses for sale as of March 29th each year in an eastern Massachusetts town:

If you want to move to this particular town during the spring selling season, you have 15 houses to choose from. Fifteen, that's it. Normally there would be 3 or 4 times as many homes for sale at the end of March. A lawyer for a decent sized Florida homebuilder told me that they are sold out of new homes until 2024. So, even if you have money, its very difficult to buy a home right now. There is no inventory of homes anywhere in the USA.

If the past is any guide, homebuyers paying current prices will face a decade of 1% appreciation. If inflation is out of control over the rest of the decade, then home prices will lag inflation by about 4%. Buying a house is a lot smarter than renting, but don't expect anything spectacular over the next decade if you are buying in 2022. For those looking to rent, they will lose all their money on rent (i.e. the proverbial "pissing it away"), and for those looking to purchase a home, the best case is keeping up with inflation and the worst case is lagging high inflation by 4% a year which means you will lose 1/2 the money on your house over a decade. Buying still beats renting, and it probably always will.