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A Lesson on Real Estate Appreciation

Is my house going up in value? How much; how fast? Seems simple enough.

At the root of this issue is whether real estate is a good and reliable investment. People want to know what they can expect out of their property when they sell it to move, or to pay for college, or for retirement. As is often the case, the issue is more complicated than it appears to be and it is aggravated by misleading information in the news almost every month. Specifically, appreciation is often confused with the ‘average’ or ‘median’ sales price. Please note: I am neither an economist nor the son of an economist; I am just trying to help our clients listen critically, speak intelligently, and make good decisions for their futures.

In accounting the attention is more on depreciation than appreciation. How much less value does the asset have this year than last year because of age and use according to accepted standards so that I can ‘write off’ value for tax purposes? Depreciation is good. In housing, appreciation is good.

In housing, I think all will agree that the normal dynamic is the appreciation of property values. And yet we have a tough time agreeing what the appreciation rate is. Reportedly, the National Association of Realtors ® have promoted the idea that since the Great Depression housing values have doubled every 10 years, except for the current 10 year period. That is100% appreciation every decade, which I understand is about 7% per year compounded. On the other hand, Robert Shiller of Yale University tells us that since the late 19th century in America appreciation historically has been about ½% per year. Do you see why communication among human beings is so challenging???

Let’s try to understand what is really being communicated. Housing value increases for a wide variety of reasons. Purists don’t consider all ‘value’ increases to be ‘appreciation,’ so defining one’s meaning is necessary to effective communication. [ul_list icon=”tick”]

  1. Many people include inflation as a legitimate cause of appreciation. That is understandable since real estate is historically a good hedge against inflation (the devaluing of money) by staying ahead of it. Some do not include this in appreciation.

  2. Capital improvements such as repairs, remodeling, and updating, increase value but is that really appreciation? Just as depreciation is caused by letting an asset degenerate; good maintenance and updating can be the cause of increased value (at least).

  3. Should changes in inventory be factored as appreciation? Decreased supply (reduced inventory) seems to be a factor for appreciation. For example, people often say that land is more valuable because “they are not making any more of it”. Yes, but we still have a lot of land to use; does that really affect the price? Then consider Oregon with its legendary land use laws which decreased supply not just as an issue of physically available land but of legally available land that can be built on. This intense lack of supply certainly increases our prices compared to a state like Texas with an abundance of land and more liberal land use laws.

  4. Increased demand in certain areas can be caused by a wide range of economic factors (e.g. jobs in North Dakota now, interest rates, personal income, etc.) and social conditions (population growth, growth of a world class wine region, migration to the Sunbelt, etc.).

  5. Current conditions have an effect on values such as the crime rate or the unemployment rate, demographic changes, institutional paradigm shifts (e.g. Detroit), the demise of a major employer (Evergreen), or other ‘enjoyment of life’ issues. Is that appreciation?

  6. Sometimes ‘appreciation’ is really something else altogether but it still may cause prices to rise. After WWII the advent of mortgages/trust deeds allowed many more people to buy homes over a long period of time which impacted pricing. Today our houses are also much bigger than they have been anytime in the past. We would expect these homes to be worth more money because they are larger and more luxurious, but it is not really related to appreciation. [/ul_list]

What Is A Normal Appreciation Rate?

What might surprise most people is that pure housing appreciation is normally a very low number. Recently I read this, “When adjusted for inflation, American home prices increased by an average of about half a percentage point per year from 1890 through 2008, according to data compiled by Yale University Professor Robert Shiller.” (By Luke Mullins of U.S. News & World Report). See interesting notes in Wikipedia regarding the Case-Shiller Index which monitors the housing market pricing [pullquote]One reason the long view of history is important is because it shows that housing appreciation is closely tethered to the rate of inflation. If it were not, then in time more and more people would be forced out of the housing marketplace. If prices continued to go up faster than our incomes, then our ability to buy them would continue to decline and fewer and fewer people would be home owners. In reality, more and more people buy homes today, not less.[/pullquote][space10]

Robert Shiller says .5% is normal for pure appreciation (factoring out inflation). Many authorities talk of 2% or 3-5% per year. I suggest that the latter numbers include inflation variables. Healthy appreciation of this kind it seems to me is about 3% when economic conditions are normal.

But I Heard…

Every month I hear in newscasts that the price of housing is up a ridiculous amount. In 2012 numbers such as 27% over the last year were cited. In 2013 the numbers are more modest such as 15%. I hear Realtors ® telling people at local meetings that their homes are worth 20% more than they were last year. Moreover, some seem to be warning buyers to buy new construction homes Lehi Utah, or like properties quickly because prices are rising rapidly. Is that for real? When I meet with people and tell them what their properties are really worth in the current marketplace they either are disappointed or think I am incompetent. Yes, in a sudden housing recovery price corrections can take place quickly as they have with luxury homes so buyers do need to be aware but that is not appreciation.

Are these numbers made up? No, they are just mis-applied and mis-interpreted. Here are two of the worst offenders:

The Average Sales Price

In 2011 we were at the bottom of the housing market depression (for those of us depending on housing for a living it seemed like it). Luxury properties were down 50% from the highs and were not selling. In fact, about the only homes selling were very low priced; the bank-owned, short sales, and other distressed properties. In 2012, most notably in Portland the recovery began with an explosion and the race was on to get the best values at historic lows before they were gone. Everyone wants to buy at the bottom. Luxury homes sold quickly and the prices jumped rapidly. The rest of the market came to life again in all price levels. The rate of sales increased dramatically.

If you averaged the sales prices in 2011 (low prices dominated by distressed sales) and then compared the average prices of 2012 (higher priced properties and the whole market selling) what would you expect to find? 30% higher average prices? Yes! Now compare the 2013 with 2012 when even broader market forces were healthy and many price ranges corrected and now new housing is vibrant for the first time in 7 years and what would you expect the average prices of 2013 to be? Better, yes! But not 30% higher. We are now comparing with 2012 which was good, not distressed. I would expect perhaps 15% better (and they were).

The average price helps us see the relative health of the whole marketplace by comparing it with other years. It’s number can be easily skewed by one or a few very high priced sales which drives the number very high. It does not tell us anything about the price of your home specifically; certainly nothing about appreciation. It tells us more about whether market conditions are favorable to getting any home sold.

The Median Price

The median (“middle”) price is more helpful in seeing the direction of value in the current housing market and even the relative health of the marketplace but it has no bearing on your particular home’s value. It shows the midpoint where half of the homes are below this mark and half of the homes are above this point. It is not subject to skewed anomalies like the average price is. Here is how it is helpful: [ul_list icon=”tick”]

  1. If the marketplace is saturated with distressed properties and distressed sales, then the median price is pulled way down. It is an unhealthy market.

  2. If buyers are not willing to spend a high amount of money in the marketplace because of uncertainty and instability then they might buy for $400k but not for $600k even though they can afford it. This reduces the median price and reveals the weakness in the market. If suddenly more people spend $1 million plus then the median price goes higher and the market is judged to be healthy.

  3. The median price is compared against other times to see the relative health and value of the housing market over time as compared with other known market conditions. For example, today we compare it mostly against the top of the market in 2006/2007 to see how the recovery is doing compared to the highs we saw before the crash. [/ul_list]

The Average price and the Median price of often large numbers; the rate of appreciation is more often a low number. Only the last one applies directly to your own home. [pullquote]Only a comparative market analysis or an appraisal can tell you what your home is worth in the current local market. [/pullquote][space10]

To find the rate of appreciation one then needs to compare this number against past valuations of the same property and then factor out issues which are not related to appreciation (e.g. an addition). Many factors contribute to your value beginning with Location, Location, Location. Our work is to help you understand your value and your market and then you can see if your home has appreciated or depreciated. We can also help you understand how to improve the value of your property whether that is appreciation or not.

Randy McCreith, Principal Broker Cell: 503-310-9147 Fax: 866-281-6653 Bella Casa Real Estate Group


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