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Saturday, November 24, 2012

How the real estate math works...


There have been lots of positive stories about the real estate market coming back lately. They are all good news and for the most part true. One headline seemed particularly positive when it stated that “Home values up 18% locally.” That is true, too. When you read the story the author claims that home values have risen 18% from their low point about 18-24 months ago. Much of that quick rise in values the author correctly attributed to the short age of inventory. Buyers are bidding up what homes there are on the market.

Home values in this area fell between 30-40% from their 2005/6 peaks during the recession. So, many people read that headline and may think, ”18% gain,  great I’ve regained about ½ of the loss”; but, that’s not how the math works.

For the sake of simplicity, let’s say you either bought or refinanced at the peak of the market a $300,000 house. During the recession that house lost 1/3 of its value (again for simplicity’s sake); so it fell to $200,000 in value by 2010. So the owner lost $100,000 in real value during the recession. Now he reads that home values have gained by 18% during the last two years. Great! He’ better than half way back. Right? No, let’s do the math on that. That 18% gain was from the low point of $200,000 or a gain of $36,000 from the bottom. That’s only 36% of the loss that he suffered, not 50% or better.

The other factor is to understand the real, underlying appreciation; which is much less than the supply driven inflation of prices. The true appreciation is believed by most experts to be only 3-4% per year, which is back to the historical real estate appreciation curve. Once the inventory situation stabilizes, with more houses on the market, we will again see the true appreciation picture emerge. That is why most experts have also been predicting that it will take most homeowners a decade or more to recoup their losses.

During the inventory-driven run-up of apparent values we have seen problems with sales that are driven by low appraisals. That is because the appraisers are not factoring in the increase due to the tight supply as quickly as the market. They will continue to lag the market a bit and that will continue to cause problems as buyers make bids that the appraisals don’t support.

 So when you read reports that home sales values are up by some percentage, just remember that they are referring to year over year increases and that we are starting back from a fairly deep hole. Yes the values are up, and that’s a good thing if you’re a seller. For buyers, that means that you should act now because the prices are only going to go higher. The bottom of the market is behind us, but there are still great deals to be had.

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