Historical Prices and Inflation

I had been meaning to do this one for awhile, but never got around to doing all the number crunching... hopefully you guys will find this entry interesting, cause it took a fair bit of work.

As you have likely deduced, that is a graph of the historical average residential price from January 1962 right through February '09. Looks rather dull until 2006 when suddenly things went crazy. Prior peaks and troughs look quite gradual, and the big boom/bust in the late '70's early 80's doesn't seem so big.

But when we adjust for inflation...

That tells a bit of a different story, eh?

For those curious, I used the Bank of Canada's inflation calculator, and did all the calculations in 2009 dollars, since that's what we're dealing with today.

As you can see from that graph, when adjusting for inflation, those that bought at the peak of the prior bubble, didn't recover their initial investment for 25-30 years... coincidentally just after the current boom really kicked in.

That's some very unsettling news for those first time buyers that bought in in the last two years. Also a reality check for all the young people who thought real estate never goes down... it can, has, and has done it right here in Edmonton.

The late '70's bubble was a bit of a different beast then the current one. The run up took about 5 years... things levelled off for about 5 years.... then declined for about 5 years. Quite gradual compared to the relatively explosive run up from January '06 through mid '07... then the decline started almost immediately.

I plan on doing a comparison of the two bubbles later, so I'll move on to something else. But there is a lot interesting stuff in there.

Here we see the inflation adjusted prices, against a curve of anticipated prices assuming 1.8% growth above inflation. The 1.8% figure is somewhat arbitrary, I just took the prices from 1962 and 2005 and calculated the annual growth, since it seemed the market was reasonably balanced in both years. The curve also nicely dissects the other one, so I'd say it's a plausible figure to go with.

In any case, we can see that the peaks and troughs always return to the anticipated curve. The bubbles far exceed the line, while the troughs tend to follow it a bit closer. It's interesting to note that the largest trough (late 90's through early 00's) was not so much caused by dropping prices, but instead by stagnant ones.

This is a behaviour that I wouldn't be surprised to see repeat itself once our current bubble has returned to Earth.

What should be a very startling observation from that graph for first time buyers is that even as far as prices have already fallen, they're still ~$100,000 higher then the anticipated curve. That's a rather scary prospective fall, and surprised even me when I first noticed it.

Here is one more graph just for a little bit more food-for-thought.

This one is just something of a melding of the aforementioned. This is the actual unadjusted average residential price from graph one, plotted against the anticipated curve from graph three with prices adjusted for their times.

You'll notice the anticipated curve in this case isn't nearly as smooth as in the prior graph, that's because inflation varies from year to year, and that curve is of inflation + 1.8%.

Again, because the numbers are unadjusted for inflation, everything appears muted compared to the adjusted figures. So, while the current bubble looks quite extreme currently, should we have another boom in 30 or 40 years our current one will look much less extreme, and the one from the 70's probably won't even register.

Anywho, hope you found this somewhat interesting and could follow along. I was just hoping to convey that looking at raw numbers can be misleading over a long time span, and thus how important it is to account for inflation.

It's quite sobering to realize that those who bought during the peak of the last bubble took at least 25 years to see their property values recover to what they paid for them when accounting for inflation. It should also serve as a warning to those looking to buy into the current market, as prices are still well above historical measures.