NEW YORK (CNN/Money) - I'm considering buying a house for $799,000 in a highly desirable town in New Jersey. But with a price that high, I wonder whether it could possibly appreciate. Do you think the value will increase, or is it possible I could end up not getting my money back even if I stay for 10 years?
-- S. Joseph, New Jersey
You've got to be careful about how you use words like "high" when it comes to the price of houses -- or, for that matter, stocks or other assets. Is $799,000 high? That's hard to say.
When I was looking for a home in the suburbs of New York City twelve years ago, I thought the asking prices of $300,000 and up were astoundingly high. It was hard to imagine that people would be willing to spend much more than that for a home. Today, however, many of those same houses are selling for two to three times what they fetched back in 1992.
Fact is, home prices do rise over time. Generally, prices rise at about one to two percentage points above the rate of inflation, although that increase can vary substantially from town to town.
In areas where there's plenty of land for new development and builders have an easy time putting up new homes, the rate of inflation tends to be lower than in places where there's little room for new homes or there are other barriers, such as tough regulation, limiting the supply of housing.
An area's rate of income and population growth also affect the path of housing prices. Not surprisingly, vibrant areas where incomes are growing and people are moving in tend to have higher house appreciation rates than areas where growth is stagnant and people are moving out.
And although house prices do tend to move up over time, that increase does not occur in a straight line. There can be periods where house prices climb at a slower rate than inflation, or even drop in value.
Outright declines in home prices are relatively rare, but they do occur -- and not just in deteriorating neighborhoods. Paradoxically enough, many areas where home prices have the most explosive moves upward also have the highest potential for prices to decline.
That's because consumers in some towns -- or neighborhoods within certain cities -- develop what Yale finance professor Robert Shiller has described as a "speculative attitude." Essentially, people view homes as a scarce asset that they've got to own at virtually no matter what the cost. Otherwise, they'll be priced out of the market.
This leads almost to a bubble mentality. While that leads to high rates of appreciation while the bidding frenzy is on, prices can also drop if they rise to the point where people begin to see them as absurd or if the number of people who can afford them declines significantly, perhaps because of a setback in the economy.
In fact, we saw such a phenomenon in some cities on both the East and West coasts where, after surging in the late 1980s, home prices slid by 10 percent or more and took seven to 10 years to recover.
Could we see a downturn in house prices again in the near future? Well, certainly the prospect of rising interest rates isn't a good thing for home prices, since higher mortgage rates will make homes less affordable.
That said, however, rates remain relatively low by historical standards, so unless we see them really zoom up, I doubt they'll precipitate any severe dropoff.
More importantly, though, there is no one housing market, as there is a stock market. Which means that while national economic factors can affect the general trend in home prices, prices can still react quite differently from city to city and even in different neighborhoods within cities. Housing, like politics, is local.
So before I put in a bid on a house in that "highly desirable" town, I would first try to get a sense of what prices have done over the past few years.
Have they ratcheted up many times over? Are homes selling within a few days well over the asking price? Is there evidence of a "speculative attitude," a sense that buyers are engaging in a feeding frenzy? Does the climb in prices show any sense of leveling off -- has the number of days a house is on the market increased or decreased recently? A real estate agent should be able to help you get a sense of what the situation is (although you'll want to keep in mind, of course, the agent has a vested interest in selling you a home.
The hotter the town is and the longer it has been hotter, the more careful you should be about buying. That's not to say you shouldn't buy. But you'll want to consider issues such as how much you'll want to bid, how much of your income you want to devote to purchasing a home and how long you're likely to stay there.
The longer you plan to stay, the less risk there is that you would end up selling at a loss. But in assessing how long you're likely to stay put, remember that factors beyond your direct control, such as a layoff or job transfer, could cause you to sell sooner than you expect.
To gain more insights into the current state of the housing market and how you might play it, I recommend you check out the Real Estate section of our site.
You should also read the special report on the housing market and real estate that appeared in MONEY's June issue, which includes stories such as "What is your house worth?" and "What's next for home prices?"
Of course, neither I nor anyone else can tell you exactly what's going to happen to prices in your area, or anywhere else. But the more you know about what drives home prices and how they tend to behave, the more informed a decision you can make about whether and what to buy.
