Home Appreciation

Appreciating Appreciation

When property values go up, homeowners cheer and home buyers are forced to dig deeper into savings to buy. But appreciation is an unpredictable thing. Learn how to handle it!

Think of appreciation, an increase in home values, as the paper profits in real estate. Paper profits exist only on paper--in this case your deed--until you actually sell the house. If you buy a house in a rapidly appreciating area, there is no guarantee that property values will be the same or greater when it comes time to sell whether you live there five years or 30. The economy could sour or your neighborhood may lose its luster. Furthermore, if you buy at the height of an upswing, when demand ratchets up prices, you may overpay. Just like in the stock market, the flip side of a boom is a bust, or at least a correction. If you overpay, and prices settle out 10 percent lower down the road, you may not recoup all of your investment. The lesson in all this: Appreciation is a nice thing to have, but not something to bank on when you buy a house.

TIP: If you're buying in the middle of a big price run-up, try to avoid overpaying by making your offer more favorable in ways other than price, such as closing early or reducing the number of contingencies. Also be prepared to give houses a more rigorous look the first time around so that if you must submit an offer quickly, you're comfortable with what you've seen.

What affects appreciation
Almost every aspect of the national economy affects real estate appreciation: employment levels, healthy businesses, housing supply and demand, affordability and, of course, interest rates. A healthy economy and low interest rates drive demand, which pushes up prices and appreciation. Regional economic changes come into play as well, at times whipsawing housing prices up and down.

But demographics play a significant role, too. In the 1980s, housing demand soared as the huge number of people born in the 1940s and '50s hit the market. Prices went up and many areas experienced appreciation that was greater than the rate of inflation, making real estate not only an investment in shelter but a profitable investment as well. As this group has settled into homeownership, lower demand has slowed appreciation to below inflation, making real estate less profitable than, say, mutual funds.

This doesn't mean you shouldn't buy a house, but you should understand how appreciation is playing in your market and in the neighborhood where you want to buy:

Look at recent sales: Do a comparative market analysis or go through public records at the tax assessor's office. You should be able to get a feel for sales volume, price direction and whether final sales prices are exceeding asking prices (a sure sign of a hot and appreciating market).
Pay attention to local business news: Monitor reported real estate trends, but also find out about new industries coming to your area or other economic changes that could dramatically affect the supply and demand of housing.
Know the neighborhood: Find out the recent appreciation history of the area where you want to move. Have prices steadily risen, bounced up and down, or been stable over the years? Is the neighborhood historically been a desirable one, either because of its amenities or its affordability?
Is there a lot of new development nearby? A sudden glut in the supply of new housing can lower property values in existing areas.

Buying on the upswing
If you are going to buy in a rapidly appreciating area, weigh your decision carefully, Compare the after-tax costs of renting with the after-tax cost of owning over five years: Renting may pencil out as the better bargain for now. Rent costs should include rent, insurance and utilities. On the ownership side, tally up your loan payment, property taxes, insurance, utilities and estimated maintenance costs against deductions for mortgage interest and property taxes. If you decide to buy:

Buy as much house as you need, not what you can afford: The bigger the house, the greater the proportion you'll possibly overpay. If you have down payment left over, invest it elsewhere.
Avoid a low-down-payment mortgage: Should property values drop, and you have to sell for some reason, you may not have enough equity in the house to pay off the mortgage and the costs of selling the house, much less walk away with any cash yourself.

Risky business
Many homeowners use appreciation as a way to draw on the equity in their house. If you bought a $125,000 house that's now worth $150,000, you could borrow much more than what you have invested so far when you take out a home equity loan. But beware. If property values plunge, you could end up owning more on the house than it's worth, which could be a real problem if you had to suddenly sell.

The bottom line
Consider appreciation a surprise, not a sure thing, many experts advise. Buy a reasonably priced house in a stable and likeable neighborhood, invest in home improvements that add value (not eccentricity), and you are much more likely to get your money back when you sell. You may even make a profit, especially if you avoid buying when the market is overheated. Just don’t plan to retire on your home's nest egg.