Revert to the Mean

24th December 2008, 04:23 am

The news on Tuesday was bad for housing. According to the Federal Housing Finance Agency, U.S. home prices fell 7.5% over the 12 months ending in October. We do not plan to sell our house anytime soon, but I thought I’d take a look on zillow.com and see where our house stood in comparison to the rest of the nation.

The value of our house is above the mean, but I won’t get into the details of that. The interesting thing to me is the percentage increase in value over the past 10 years. Zillow has a handy chart that lets you compare the percent change in value of your house to the median price change in your region as well as the entire country.

It is interesting that our house has pretty much tracked the nation in percent increase during the first 9 years and then decreased along with the average in the last year. I find it fascinating that the median in our state tracked much higher in the first 7 years and then fell more in the past 3. Eventually I expect it will revert to the mean.

Next question is, where is the mean?

Zillow tells me that our house has increased in value by 97% over the past 10 years. That equates to a compounded annual growth rate of 7%. Prior to the housing bubble of this decade, housing prices pretty much tracked inflation. Sure, there have been areas around the country that gained much more during any specific decade, and there was a good gain overall after WWII, but that was just reverting to the mean after the Great Depression. Other than that, it has been pretty much in line with inflation. The chart below from a 2005 article in the New York Times shows median housing prices in the U.S. from 1890 to 2005 adjusted for inflation. It is generally flat, or a very slight increase, until the housing bubble of this decade.

Inflationdata.com says that the inflation rate based on the CPI has averaged 3.43% since 1914. Even if we say house prices should appreciate by something a little higher, like 4% annually, we have a total percentage increase over ten years of 48%. Even 5% says we should only see a 63% increase over 10 years. To drop from a gain of 97% to a 63% total gain requires that housing fall another 17%.

The remaining fall may not be that much if we get the remainder of the TARP money actually applied to bad mortgages, but eventually, we will revert to the mean. 100 years of data say so.