# The Surprising Truth About Interest Rates and Real Estate Values

For the last five years or so the Federal reserve has been working hard to keep interest rates low (by printing money and calling it “stimulus”).  Last week, they announced they would taper their stimulus, which should cause a spike in interest rates.  As a fellow real estate investor, I asked the obvious question: how will this influence the home prices?

Pundits love to get television and spout how increased interest rates will make it more expensive to borrow money, which in turn will deflate home prices.  Any talking head can come up with a theory, but you can’t place any value on it until there is evidence to support it.

So…what does the data say?

## Interest Rates and Home Prices

There are a number of interest rates to choose from, but for the sake of this post I’m going to use the fed funds rate (the interest rate at which banks lend money to one another).  You can make an argument for using a different rate, but the results are similar.  For home prices, I’m going to use the Case-Shiller Home Price Index (HPI).

In all of my examples I use annual data from January 1975 through January 2012.

Here is a scatter plot showing how interest rates and home prices correlate with one another.

Above I did a simple linear regression on the data.

If you’re not very statistically inclined, what you should care about is the R² (0.4305).  This number ranges from 0.0 to 1.0.  The higher the R², the more likely two things are correlated.

An R² of 0.4305 is low.

How low?  Well let’s look at another correlation.

## Population and Home Prices

At the end of the day, home prices should be driven by housing demand.  The most obvious way to calculate housing demand is by looking at the population.  So…let’s do that.

Here, the R² is 0.9376 (1.0 is the maximum).  That’s huge!  We can say with an incredible amount of certainty that home prices and the US population are correlated.  I could make an argument that home prices are set by population, but we don’t have enough data to say that for certain.

The difference between the R² of 0.9376 for the US population and 0.4305 for the Fed funds rate is enormous.

To drive that point home, I’m going to look at one other indicator.

## Oil and Home Prices

Let’s run our regression on oil prices versus HPI over the last 37 years.

That’s an R² of 0.543…which is higher than the R² for the Fed funds.

## Wrap it Up: How Much Does the Fed Taper Matter?

What’re the odds interest rates influence home prices?  Not much.

Indeed, oil has a higher correlation.  Now, I’m not saying oil prices drive the real estate market.  Rather, I’m using it as an example to show how insignificant interest rates are on historical home prices.

As a real estate investor you should be focusing on more fundamental drives of the market: like housing demand.

Photo: Paul Nicholson

For the last five years or so the Federal reserve has been working hard to keep interest rates low (by printing money and calling it “stimulus”).  Last week, they announced […]