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Saturday, December 1, 2007

The amazing deflating home...

American car buyers are used to the idea of the car as a depreciating asset. You buy it and 3-4 years later it's worth about 20% of what you paid for it. If you hold on to the car long enough and it's not one of 2-3 Million of that model made, it may actually start back up the value curve, assuming that you've kept it in good condition. Just look at the 70's muscle cars for extreme examples of that - many are worth 10 times what they were worth brand new.

The same is not normally expected of real estate, unless it is commercial real estate. Houses, if kept up, normally are (or were) expected to appreciate over time. For a while in the late 1990's/early 2000's the rate of appreciation in some areas was consistently in double digits. Not any more. We've actually had a flat or falling values market for 2-3 years now; so, that house that you bought brand new in 2003 is likely worth 8-15% less that when you bought it. Bummer!

Of course, one major difference between the house and car scenarios is the length of time that each is financed; and, so, how fast they're paid off. Cars are normally financed for between 3-5 years. If you go 5 years or more, you'll likely be paying off the car as it's value is nearing it's low point. Depending upon the make, model manufacturer, and it's condition, it may still be worth from 20-40% of it's original value and you won't owe anything on it.

Buy a house and pay for 5 years and you will barely have made a dent in the principal that you owe. Almost all of the money that you pay in the first 10-15 years goes towards interest. So, 5 years down the road you take a job transfer or get laid off and try to sell the house. It's then that you discover that you might well owe more on it that it is worth in the market, especially if you bought it with one of those sweet sounding 100% mortgages. If you put at least 10% down at the outset, you might be above break even 5 years into the loan, but likely not. It costs abort 7.5% to sell the house, so if there was even a little depreciation - 2.5% or more - you'll be underwater on the house. In our area the depreciation has actually been in the 8-13% range, so you can see why so many people are forced into foreclosure.

So, do we have a future to look forward to with houses that depreciate like cars? Not likely over the long run; however, for the immediate future, homeowners need to understand that they have lost value, they continue to loose value and they will likely loose value for the next year or two. When we eventually return to historic home appreciation rates, likely within the next two years; it will still take a good 4-5 years for the values to climb back up to where they were in the early 2000's. I guess it's like the words of advice in the old Kenny Rogers song about the gambler - you gotta know when to hold em and know when to fold em. Ask your Realtor for advice - he/she's not a gambler, but a professional.

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