3 Methods To Determine Real Estate Appreciation
If you saw today's Weekly Special Real Estate Report, then you should know that real estate appreciation is exactly "zero" since ten years ago.
You also know that home prices are the same as nine years ago, meaning there is a difference between "price" and "value" in real estate.
You might not think that this matters, but if you are at all curious about appreciation and depreciation, then I recommend you see why it does.
Estimating Real Estate Appreciation
Figuring out what is going on with home values has a lot of moving parts. From what I can tell, there are three different ways that we can estimate appreciation in the real estate market, and each process has its flaws.
- Using average (or median) sales price changes over time - This is the process that we most often see utilized in real estate reports nationwide. It is grossly flawed in that tracking prices tells us how much money (on average) buyers are currently spending, but it does not consider what they are buying.
During the housing market recovery, it was very common to see home values dropping all-the-while average home prices were rising. Why? Because interest rates were dropping, buyers could get "more house" for their money, and they were willing to spend more money so long as their monthly payments remained the same.
But just because they were spending more money does not mean that sellers were receiving more money. The glut of homes made the supply and demand imbalance lean far to the buyer's side, so homebuyers were getting nicer homes without changing the monthly budget. Home prices were falling, but the average sales price was rising. The opposite will be true some time in the future when interest rates rise.
So using average sales prices is the least effective way to determine real estate appreciation or depreciation in any housing market.
- Using same-property historic sales information - Case-Shiller is a company that tracks the top 20 housing markets in the US using a comprehensive survey of historic home sales.
Their indices are calculated from data on repeat sales of single-family homes and likely produce the most accurate estimate of real estate appreciation for the 20 markets that they cover. But their methodology has its flaws too.
Case-Shiller does not account for upgrades and improvements to homes over time (like adding a bedroom or a swimming pool), and most importantly, it takes a team of PhD's to compile and maintain their index. Their process might be the best, but they only track the 20 largest markets in the US because the work is far too cumbersome to be used for the rest of our real estate markets.
- Using average (or median) price per square foot changes over time - This is the best choice for tracking real estate value movements over time.
Using the average price per square foot over time is flawed in that it does not account for amenity items (pools, improvements) that change over time, and it does not address land values underneath the home (consider a 2000 square foot house on a half-acre versus a 2000 square foot house on 200 acres, are both worth the same price per square foot?).
But I believe a large enough data set (sample size) reduces those factors to a similar level as found in the Case-Shiller Indices. Price per square foot information is readily available to anybody who has access to the local Realtor MLS, and it returns an opinion of real estate appreciation trends that just might be more accurate than the Case-Shiller Index. Why?
Because instead of sampling a data set of homes with past sales histories, a proper value analysis takes all existing home sales (meaning removing new home sales) and recording their price per square foot. By taking in the entire MLS, it is likely that you are measuring more than 50% of all homes sold in your local housing market.
Home Prices Versus Home Values
Home prices and home values do not always move in the same direction, and that is because the "amount of house" they are buying changes. Market influencers like mortgage interest rates and the strength of local employment determine the strength of the buyer pool, while supply and demand determine the direction of home values.
Take a look at the median home size in Tallahassee. The real estate graph below shows how it has changed over time. Currently, home values are the same today as they were 10 years ago, but buyers are choosing to buy larger homes right now. I believe that simply is a result of lower mortgage interest rates allowing them to purchase "more home" for their desired monthly budget.
Ultimately, there is no exactly right way to calculate appreciation (maybe some of my super-math readers will chime in the comments and tell us a better way). But now that you have read through this explanation, you won't be so quick to stomach the national reports that have been screaming soaring values when much of it was simply soaring average sales prices.
If you want to know how values are going to move in the near and long-term future, you have to focus more on the supply and demand dynamic in your market. If you are grossly over-supplied, you should expect values to decline, regardless what average home prices are doing.
If you want to know more about how your Tallahassee home has been impacted by real estate appreciation, please drop me a note and we will schedule a time to analyze your home's value in the market today.