Here's Why the Market is Exactly Where It Should Be

I’m not one to predict the market. Frankly, I am a firm believer in dollar-cost averaging.

For those of you who do not know what dollar-cost averaging is, it means continuously purchasing real estate despite market conditions. I will buy one or two properties every year, regardless of whether the market is up or down. Over time, this will average out, so that the state of the market has a limited impact on my overall portfolio.

Predicting the Market

However, I talk to a lot of real estate investors and real estate investors to be. What I gather from many of them is that they want to wait to buy until the market crashes again. My response to that is, “how do you know when the market is going to crash?”

You don’t. You can’t know. One of the smartest investors to ever grace this earth—Warren Buffett—has even said, “I don’t know anyone—or anyone who knows anyone—who can consistently time the market.”

While I stand by my initial point, I did decide to do a bit of research on the U.S. real estate market as a whole. I was curious to see if these people saw something. Were there any indicators showing a potential decline in the market? I know that markets differ based on each city and town. I am also aware that there are thousands of variables you can look at when determining market health. This article is meant to show a more holistic picture with some of the most common metrics used.

I also realize that there are unlimited external factors that could cause the market to tank or spike, but based on current known conditions, I want to understand in what direction the market will likely go.

What did I find? I found that the overall market is exactly where it should be — or perhaps a bit below where it should be. There are no signs of tremendous growth, and no signs of an impending crash.

Let’ts take a look.

Population vs. Properties Sold

First, let’s take a look at comparing the U.S. population against the amount of properties sold. In this graph, the “U.S. Population” (blue) uses the left axis and the “Properties Sold” (orange) uses the right access.

All data is taken from the U.S. Census.

Analyzing the Data

All else being equal, as the U.S. population increases, the amount of people eligible to purchase homes increases — and therefore the amount of properties sold should also increase. As you’ll see in this graph, however, this is not the case. There are clearly many other factors that cause these spikes and troughs.

In the 1980s, record high interest rates made it less affordable for people to purchase homes.

In the early 1990s, the stock market crash of 1987 had destroyed many Americans’ savings, making it more difficult for them to buy homes.

From the early 1990s until the mid-2000s, the real estate industry realized impressive growth. Until 2007, when relaxed lending standards allowed people to purchase homes they could not afford, ultimately causing them to default on their loans.

After reaching historic lows, the market has continued to climb back. Despite many people thinking house values are artificially high, the amount of homes sold is about equal to the amount of homes sold in the mid-1990s when the population was about 60 million people smaller. To me, this suggests that demand has not met supply, and prices should continue to increase (albeit at a slower rate).

Population vs. New Construction

But what about all of the new construction? The increased supply would meet much of the demand, causing prices to stagnate or even decline. Let’s take a look. Population (orange) uses left axis and New Builds (yellow) uses the right.

All data is taken from the U.S. Census.

As you can see here, despite there being an ever-increasing population, the amount of new builds has declined over the past 50 years. Why? Figuring this out would take a whole new study within itself and is beyond the scope of this article.

Over the past 10 years, as the economy has recovered, you will see that the number of new builds is steadily increasing. It is increasing much faster than the U.S. population, but it still has a way to go. If this trend continues, it may cause a decline in housing prices.

As of right now, the new builds have not quite caught up to the population. However, this metric is the one I am most worried about. Especially as the average age of homeowners increases — with millennials having a higher propensity to rent.

Properties Sold vs. Interest Rates

Let’s take a look at the properties sold compared to the interest rates. Typically, interest rates and properties sold are inversely correlated. In other words, as interest rates rise, properties sold decreases. Why? Because all else remaining equal, a higher interest rate means a higher monthly payment — which means it’s harder to afford a house at the same price if interest rates had been lower.

All data is taken from the U.S. Census.

If you look at the graph above, you’ll notice that from their peak in the 1980s, mortgage rates have continuously declined. When you compare this to properties being sold, interest rates are still at a historic low — meaning people will likely continue to be able to purchase housing. This increases the demand for housing. And with increased demand comes increased (or steady) prices.

While interest rates will likely rise in the next few years, there is still a ways to go before it has a significant impact on the amount of properties sold. Once the increased interest rates cause the properties sold to decline, I believe we will see a decline in housing valuations.

Median House Price Over Time

The biggest reason why I believe people are quick to jump to the conclusion that the housing market is inflated is that prices are higher than they have ever been. As they should be.

From 1968 through 2009, homes, on average, appreciated 5.4 percent per year. If we assume the same trajectory (see chart below), you will see that property values are almost exactly where they should be.

All data is taken from the U.S. Census.

The reason why it feels like the market is artificially inflated is that it is recovering from one of the greatest recessions in U.S. history. Over the past few years, real estate prices have just regressed to the mean.

Conclusion

While we could go in and debate every point, many of the market health indicators suggest that the market is exactly where it should be, or it may even have room to grow.

Nothing suggests that there is an impending crash, except for the fact that house prices have risen dramatically over the past 10 years. But remember, they have risen from all-time lows.

Going forward, I suspect that we will see mild ups and downs, similar to those in the previous 75 years before 2008 (and after the Great Depression).

I do not believe we will ever see housing prices drop to 2008-to-2012 levels again.

In other words, if you continue to wait for the market to crash, you may grow very old waiting.

Despite this article defending the point that we are actually in a very normal market, I do want to reiterate my initial point: Trying to time the market is unwise. It’s akin to gambling. Take advice from the most successful investor of all time, Warren Buffett — don’t try to time the market.

What do you think?

Do you agree or disagree with my market analysis? Share your thoughts below!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.