Real estate is still a topic of great interest both here in Costa Rica and there in sunny Key West. As I am inclined to look back in time to satisfy my curiosity about the future, I found the following graph interesting. It shows the history of housing prices in the United States for the last 110 years. Robert Shiller put it together for his book, Irrational Exuberance.
In this column I’ve made no secret of my doubts about opinions so popular they achieve the status of “common wisdom.” In fact, I believe that unanimity of opinion is one true indicator of nearly certain delusion. It is an equally reliable predictor of dramatic change.
For most of my adult life, and certainly in the last five years you would have to have been locked in a vault not to have absorbed the common wisdom that “real estate never goes down.” And when measured by the amazing vanishing dollar, the common wisdom is spot on. But once we remove the illusions of paper money, as Mr. Shiller has done in his graph, certainty vanishes as well.
It’s remarkable that despite the 2000 dollar’s having become worth the equivalent of the nickel of 1900, housing prices, when adjusted for that shrinkage, were just about the same in 1990 as they were at the peak in 1895. It is equally interesting to note the many periods of time when U.S. housing prices defied the common wisdom and fell.
From 1895 to 1920 prices fell almost 50%. Prices didn’t fully recover to their 1895 highs until the late seventies, and then only briefly. Housing prices declined steadily from the mid-fifties until the mid-seventies. There were sharp corrections after booms in both the late seventies and late eighties. It is only the most recent boom that has taken us far, far from the historic mean.
And the unit of price measurement isn’t the only thing that has changed in the last 100 years. Housing units have changed dramatically as well. The average house in 1950 was a two-bedroom affair, with a single bathroom. It featured around 900 square feet under the roof. By 2000 that average dwelling was almost three times the size. It had at least two bathrooms and a two-car garage. It had central heat and air-conditioning. Dishwashers, garbage disposals, wall-to-wall carpeting, and even countertops of imported granite were no longer luxuries.
It’s true the price of a house has gone up quite a bit in real terms since the bottom in 1920. In those days you could order a Craftsman house out of the Sears Catalog for $495 and find skilled labor to assemble it for $1 an hour. But the price appreciation since 1920 hardly covers the increase in size and amenities of the average home. Based on price per square foot, the cost of housing has actually declined dramatically in the last 100 years.
Which brings us to the Fat Lady who is singing the musical question for my statistical two-step. Has housing really suddenly become way more valuable than it has ever been or are we in the gondola of a high-flying financial balloon pumped up to bursting by easy credit and dreams of avarice?
There is an argument to be made that housing in 2000 was cheap by historical standards and that it has now corrected to reflect the value of modern size and features. To do so we have to ignore the increases in productivity and efficiency that have taken place over a century of near magical technological innovation. But the argument is not without merit.
On the other hand we can reflect that occasionally, through an unpredictable but volatile mix of paper money and human emotion, assets briefly achieve prices far higher than any measure of real value would justify. Historical examples are rare but instructive. My favorite is the tulip bulb mania in Holland in 1636. For a year or so tulip bulbs were more valuable than houses, in no small part because of trading in tulip paper derivatives, futures and options, that were not unlike the sophisticated debt instruments of today. With a few impressive blips, the price of tulips returned quickly and permanently to its historical mean.
Will the price of housing also return to the mean? I surely don’t know. Not knowing the future is part of the fun. But I do know that when prices of anything stray very far from it, it is usually not for long.
