However, among all this number crunching, we recognise that home buying is sometimes not a purely financial decision.
Remember we buy houses – not a housing index
Economist Chris Dillow blogs that there is so-called “idiosyncratic risk” in buying houses. Investing in individual houses is riskier than investing in a housing index (if that was possible) – but the prevalence of house price indices mean they may be relied upon to guide investing decisions. Prices for an individual house can rise or fall much more quickly than movements in indices, which are typically derived from many house sales. It is similar to the way a single share is typically more volatile – and more risky – than a mutual fund.
Look behind the headlines
Likewise, the news flow will typically report ups and downs in the fortunes of individual shares – or companies – giving an impression of share market volatility. But beware that the same is not true for individual houses. If it was, we'd get a livelier impression of the volatility of properties.
Work out the ratios
Just because house prices have fallen slightly, it does not automatically mean that homes are cheap. Compare average house prices to average wages and to the costs of renting to get a measure of the relative cost – and an idea as to if houses are “over valued”. The eZonomics video: Are houses expensive or cheap shows how to use these ratios.
Ask if you really need to “get in quick”?
The glut of media coverage about house price indices rising or falling can skew perceptions of whether we need to act urgently to buy or sell. As explained in the availability bias article, recent or very vivid information can cause potential home buyers to overreact. Assessing risks and opportunities over a longer timeframe (and from a wide range of sources) may help overcome this thinking trap.
Work out if the returns are worth the risk
Dillow blogs that the basic economics of asset pricing provide a framework to gauge if houses give enough long-run return to justify the financial risks of buying. His analysis concludes that housing needs to offer higher returns than shares to compensate for greater risk – and that achieving this is often dependent on timing the market.
A slump can skew
In a housing market slump, the worst homes tend to languish unsold at the same time as the most desirable properties are snapped up, perhaps to buyers who have more financial insulation to bad economic conditions. As housing indices are typically based on sales, the exclusion of badly performing (and unsold) homes in a flat market can see data produced that appear better than the reality. Worth keeping in mind when trying to weigh the stability of the housing market.