What's Normal for Housing Prices?

One way to figure out the long-term trend

One key argument for a big drop in home prices is that they grew at an above-trend rate and need to fall to get back to trend. So it's fair to ask: How do we know what the long-term trend really is?

BusinessWeek started with Yale University economist Robert J. Shiller's pioneering research on the history of U.S. house prices going back to 1890. Shiller pieced together data from several surveys and then removed the effects of inflation. We calculated the growth rate that gave the best match to Shiller's data. The answer: 0.4% per year after inflation. The calculation also suggested that home prices were still on their long-term trend as recently as 2000.

This estimate comes with a caveat: It assumes that the history of prices going back to 1890 remains relevant in today's market. Choosing 1960 as the start date would raise the estimate of trend growth to 0.8% per year. On the other hand, moving the end date to leave out the bubble years would lower the estimate. Trend growth from 1960 to 2000 was just 0.2%.

But no matter which of these start and end dates we choose, we come to a similar conclusion: Home prices are still way above their long-term trend.

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