The Myth of Rising Home Prices

House modifications are a major hurdle in accurately tracking value (did the house increase in price due to capital gains or a modified larger bathroom?).Source: Eichholtz (1997)When analysing Herengracht house prices a similar pattern emerges..Nominal prices of Herengracht houses steadily increases over time..But once corrected for inflation, house prices for Herengracht houses increases nowhere as fast..Annual real returns for Herengracht houses after World War II are a meagre 3.2%..In 1973 the price was just double the price in 1628 for Herengracht homes in real terms.Why The Poor Returns?So what is it that is keeping house prices in check?.The answer lies in incentives: house prices are kept in check by classic market forces..A higher price is a very strong incentive for construction companies to supply more houses, hence exerting downward pressure on house prices..Second, construction companies operate in a competitive environment, pushing up prices above the market price will mean you go out business..Third, over the years clever civil engineers have found ways to build better houses at lower costs.But sometimes these market forces fail, and market participants go wild..Think of bubbles such as in the ’90s in Japan or ’00s in the US..Then there still exists a safety valve: when house prices do rise quickly in real terms, buyers of houses and businesses have a strong incentive to move away from those “overheated” areas..Subsequently “cooling” those areas.. More details

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