Reversion or regression to the mean is a widely-used term in the stock exchange. It is a rule that stock prices tend to go back to their long-term average.
The principle is applied, not just to the stock exchange. The theory lends itself to various business & financial decisions. Disregarding the inflation; interest rates, home prices, and stock exchange shares have the same average value over time. Let’s discuss that in the context of the real estate industry.
An overpriced home, one day, will be underpriced. When the current price is below the market average, it’s time to buy. When the estimate exceeds the market average, it’s time to sell or wait because prices will eventually come down.
The US housing industry follows a specific price pattern. If you look at the price chart, you will notice the patterns. Home values go up. Then we see a drastic decrease in values, and then we meet somewhere in the middle.
That’s not a rule, but it also not fiction. History repeats itself over and over again. People say home prices are increasing exponentially. They say a home in 1940 was $6,800. In 2000, the same property would cost you $108,100.
These statistics have completely ignored the concept of the “inflation rate.” $6,800 in 1940 were worth $83,640 in 2000. So, it is no surprise that a 6,800 home in 1940 costs approximately $108,100 in 2000. Closely monitor this pricing chart. It plots housing values from the last 40 years.
The beauty is that this chart has real values. Property values have been adjusted for inflation, and you can see how much price change happens over the years.
The thick red line indicates the inflation-adjusted price of homes in the US. Starting from 1970, we check the data until 2014. Monitor the numbers from 1970s-1980s. The prices remained near $150k. During some years, the costs were down. Sometimes, they went up.
At the end of the 1970s, we are close to $165k. The price went back to $150k in the 1980s. Then the home values started increasing in 1988. We see some fluctuations, but overall, we can see a steady increase in property prices. Beginning in 2000, we see a massive rise in prices. That kind of growth is not usual. We were not experiencing a lack of inventory. Still, home values were rising. The last thing we notice is $275k average home value in 2006. (Pre-foreclosure pricing).
Think of a spring. You can stretch it, but it will come back to its original shape. The same happens in the real estate industry. Prices had to come down, and that’s what happened during the last recession. From 2006-2012, we see a steady decrease in rates and the US market started recovering in 2014.
Housing inventory, interest rate, lending terms, and area development are the indications. They are the effects, not the causes. The real reason often is greed or fear.
In a rising market, it is the greed that is pushing the prices up. People are buying without considering past records. Fear gives birth to more fear and poor decisions. Look at the long-term average, and you can make an educated decision regarding any significant purchase.
*The photo and the chart initially appeared on http://www.jparsons.net/housingbubble/. We are only using this chart to explain the numbers.