Real house price

What Is Real House Price?

Real house price refers to the value of a property adjusted for the effects of inflation. It provides a more accurate representation of housing costs over time by reflecting the actual purchasing power required to buy a home, rather than just its stated monetary value. This concept is crucial in macroeconomics and real estate finance, offering insights into the true appreciation or depreciation of housing assets. Unlike nominal house price, which is the price observed in current dollars, the real house price accounts for changes in the overall price level in the economy.

History and Origin

The concept of adjusting economic data for inflation has been fundamental to understanding true economic trends for decades. While specific real estate indices like the S&P CoreLogic Case-Shiller Home Price Index became widely recognized in the late 20th century, the practice of deflating housing prices by a general price index, such as the Consumer Price Index (CPI), has been employed by economists to track the real value of housing for much longer. This approach gained particular prominence during periods of significant inflation to assess the underlying strength or weakness of the housing market. For instance, academic and institutional analyses have long highlighted the importance of real house price data for understanding housing bubbles and busts, with organizations like the International Monetary Fund (IMF) launching initiatives such as the 'Global Housing Watch' to monitor these developments and curb complacency among policymakers regarding the effects of housing booms and busts¹³, ¹⁴.

Key Takeaways

• Real house price adjusts the nominal price of a home for inflation, reflecting its value in constant dollars.
• It provides a more accurate measure of housing affordability and changes in wealth over time.
• Tracking real house price trends helps identify sustainable appreciation versus speculative bubbles in the housing market.
• Changes in real house prices are influenced by factors such as income growth, mortgage rates, and the overall supply and demand dynamics for housing.
• Policymakers and analysts use real house price data as a key economic indicator to assess financial stability.

Formula and Calculation

The real house price is calculated by deflating the nominal house price by a relevant price index, typically the Consumer Price Index (CPI), which measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The formula is as follows:

Where:

• Nominal House Price Index: A numerical representation of the average nominal price of homes in a specific market or region over time.
• Consumer Price Index (CPI): An economic indicator that measures the average change in prices paid by urban consumers for a basket of consumer goods and services. It reflects the rate of inflation.
• Base Year Index Value: The value of the real house price index in a chosen base year, often set to 100, which serves as a reference point for comparison.

For example, the Organisation for Economic Co-operation and Development (OECD) calculates real house price indices by deflating nominal house prices with a private consumption deflator, often using a base year such as 2015¹².

Interpreting the Real House Price

Interpreting the real house price involves understanding what the inflation-adjusted value tells us about housing market dynamics and buyer purchasing power. A rising real house price indicates that homes are becoming more expensive relative to the general cost of goods and services, suggesting an increase in the true cost of housing. Conversely, a falling real house price means that homes are becoming relatively cheaper.

This metric is vital for assessing long-term trends in housing affordability. If nominal prices are rising, but the real house price remains stagnant or declines, it implies that the gains in home value are largely offset by broader inflation, meaning homebuyers' purchasing power has not significantly improved. Analysts also use the real house price to gauge the sustainability of price increases, differentiating between genuine growth driven by fundamentals like economic growth and speculative bubbles that may burst.

Hypothetical Example

Consider a hypothetical scenario for a single-family home. In January 2010, the nominal price of a house was $300,000. Let's assume the Consumer Price Index (CPI) in January 2010 was 200. By January 2020, the nominal price of the same house rises to $400,000, and the CPI increases to 250.

To find the real house price in January 2020 relative to a January 2010 base (where the real house price index is 100):

First, calculate the inflation factor:

Now, adjust the January 2020 nominal price for inflation:

In this example, while the nominal price increased by $100,000, the real house price only increased by $20,000 ($320,000 - $300,000) when adjusted for inflation. This indicates that a significant portion of the nominal price increase was due to the general rise in prices across the economy, not necessarily a substantial increase in the home's intrinsic value or buyer purchasing power.

Practical Applications

Real house price data has several practical applications across finance, economics, and public policy. It serves as a crucial metric for understanding housing market dynamics beyond simple nominal price changes.

• Investment Analysis: For real estate investment, comparing real house price trends across different periods or regions helps investors assess the true long-term appreciation potential of properties, factoring out the distorting effects of inflation. This aids in better asset valuation.
• Housing Affordability Assessments: Governments and research institutions use real house price indices, often alongside price-to-income ratios, to monitor housing affordability for residents. For example, the OECD frequently analyzes these indicators to highlight challenges in housing markets globally¹⁰, ¹¹.
• Monetary Policy and Financial Stability: Central banks and financial regulators closely watch real house price movements as a key economic indicator for assessing potential risks to financial stability. Rapid increases in real house prices can signal an overheating housing market or the formation of asset bubbles, which can precede a financial crisis if not managed properly. The International Monetary Fund (IMF) maintains a "Global Housing Watch" to track such developments worldwide⁸, ⁹.
• Economic Research: Economists utilize real house price data to study the relationship between housing and broader economic growth, household wealth, and consumption patterns. The Federal Reserve Economic Data (FRED) database, for instance, provides extensive historical series on real residential property prices for research and analysis⁷.

Limitations and Criticisms

While the real house price provides a valuable inflation-adjusted view, it does have limitations and criticisms. One primary concern is the choice of the deflator. Using a general measure like the Consumer Price Index (CPI) might not perfectly capture the specific inflation impacting housing construction costs, land values, or local market dynamics. A general CPI includes a broad basket of goods and services, some of which are unrelated to housing.

Furthermore, a real house price index does not inherently account for changes in the quality, size, or features of newly built homes over time. As homes become larger or incorporate more amenities, their higher nominal prices might reflect improved quality rather than pure price appreciation, which a simple inflation adjustment might not fully distinguish. This can complicate the interpretation of long-term trends.

Another critique arises from the fact that real house price indices, while adjusting for inflation, do not directly factor in changes in household income or mortgage rates, which are significant determinants of actual affordability and buyer purchasing power. Some alternative indices, such as those that adjust for income and interest rates, aim to provide a more comprehensive measure of housing affordability⁶.

Lastly, real house price movements can be influenced by local supply and demand conditions that may not be captured by national averages. Regional disparities in economic conditions, population growth, and housing policies can lead to significant variations in real price trends that a broad national index might mask. For example, some regions might experience a recession while others are still seeing real gains.

Real House Price vs. Nominal House Price

The distinction between real house price and nominal house price is crucial for accurate financial analysis and understanding market trends.

Confusion often arises because people typically observe and discuss nominal house prices in daily transactions. While a rising nominal price might feel like a gain, if the overall rate of inflation is higher, the real house price could actually be declining, meaning the homebuyer's money buys less relative to other goods and services. Therefore, looking at the real house price provides a more accurate picture of whether housing is genuinely becoming more or less expensive over time⁴, ⁵.

FAQs

What does it mean if the real house price is falling?

If the real house price is falling, it indicates that housing is becoming more affordable relative to the overall cost of living. This could happen if nominal house prices are decreasing, or if they are increasing but at a slower rate than general inflation. It suggests that your money has more purchasing power when buying a home.

How does inflation affect real house prices?

Inflation reduces the purchasing power of money. When nominal house prices are adjusted for inflation to calculate the real house price, the impact of rising costs across the economy is removed. If inflation is high and nominal house prices are not rising as fast, the real house price can decrease, meaning homes are becoming cheaper in real terms.

Why is real house price important for homebuyers?

For homebuyers, understanding the real house price helps assess genuine affordability. It allows them to see if housing is truly becoming more expensive or if nominal price increases are merely keeping pace with general inflation. This knowledge is critical for making informed decisions about large investments like a home purchase.

Where can I find data on real house prices?

Reputable sources for real house price data include national statistical agencies, central banks, and international organizations. For example, the Federal Reserve Economic Data (FRED) portal provides real residential property price indices³. The International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) also publish extensive data and analysis on global housing markets, including real house price trends¹, ².