Owning a home has long been viewed as a one way ticket to wealth creation and security. And as long as house prices went only one way – which was largely up, it was an aspiration worth having. However, today, post recession, as Lucy Kellaway in the Financial Times says "If property prices are going up, then owning a house is a wise move. If property prices are falling, then renting is smarter. At the moment, no one is sure – hence the anxiety."


Source: S&P Dow Jones Indices

The financial analysis is actually quite elementary. Owning a house makes sense if house prices are going up, your interest rate is not too high and you plan to hold on to the house for at least five years. Tax deductions also make a difference. Most of us know the mortgage rate, our tax bracket, and our holding period (more or less) before we buy a house. The factor we take a punt on is what house prices are going to do. This is crucial because most of us view our home not only as a place to live but also as an investment.

So what should you consider to find out which way the wind blows for house prices this year?

1. House Price to Income Ratios
Just like good old P/E ratios, one of the most enduring indicators of housing prices is the price of a home vs. the income in an area. The Economist has mapped this in an interactive chart for various cities across the US. While their conclusion is house prices in the metros are above fair value (fair value being 100), compared to the peak ratios of 2005, it is likely prices still have a way to go. Furthermore, housing markets are notoriously inefficient and suffer from inertia which contributes to the boom and bust nature of cycles.

Price to Income Ratio

2005 Peak

Current ratio

US 20 City Index






New York



San Francisco






Source: Economist

*Compares house prices against median incomes in each city, rebased to 100 at the selected date

Also, real personal disposable incomes are rising so that will keep the upward pressure on prices.

2. What about rising interest rates?
The accepted wisdom is when interest rates go up, prices fall and vice versa.

This has been studied in-depth by the pundits. A group of Harvard and Wharton scholars explored the relationship between interest rates and house prices. Following some mind-bogglingly complex analysis, they concluded a 100 bps change in interest rates accounted for at best an 8% change in house prices (in the opposite direction). In other words, it is less important than we think.

Rates are likely to go up this year, but while it is useful for you to figure out if you can buy your home in the first place, barring a big rise in rates, it is probably not going to be a game changer for house prices.

3. The housing market is driven by expectation
Karl Case and Robert Shiller, two economists, showed house buyers pay much more attention to recent house price changes than any other factor.

The most important influence on house buyers today is what house prices have done yesterday. And the best measure of that is a real estate website like Zillow or Trulia for local house price data. Zillow has a total of 21 variables that the zealous would-be home buyer can look at, but the one that reflects what house prices have actually done is the Sale Price index (the Zillow Home Value Index is based on their estimates and not actual prices).

Sales prices for some key metros over the past year shows house prices have gone up anywhere from 7% in New York to 16% in Chicago. For the housing market at least, past performance does seem to be a guide to the future. It is likely the market will continue to rise this year, albeit at a lower rate of mid to high single digits. Zillow also lets you look at all the data for your postcode.

Zillow is also launching Indicators of Homeowner & Renter Confidence which is worth tracking.

Median sale price ($)-All Homes


Source: Zillow

So on balance, despite all the caution surrounding house price increases, there is still some room to go before the warning bells start ringing.

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Revathi Greenwood has no position in any stocks mentioned. The Motley Fool recommends Zillow. The Motley Fool owns shares of Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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