For the past several years buyers have been deeply concerned that when they buy a home they may make a mistake and pay too much if the home drops in value. This should not be as big a concern as buyers may think. Let’s explain why:
For decades now, real estate has appreciated at a rate of 5% each year. Until 2006, it was an accepted fact that real estate always went up in value. Then, suddenly because of the financial meltdown, lax lending standards, excessive home building, and ultimately great recession, prices plummeted nationwide. In hindsight, this is not surprising. With the excessive appreciation as much as 20% in a single year during the boom years, the natural response has been an over correction in prices.
According to the Case-Shiller Index and most experts, home prices have dropped so low that they are now back to 2002 prices. This price over correction has created a tremendous opportunity for buyers. A strong case can be made that just as there was no justification for the over-heated appreciation of prices in 2004, 2005, 2006, and 2007, there would have been no reason to assume that 5% appreciation per year isn’t justified. Let’s go back to 2002. Barring the crazy market conditions that occurred, the price of a home since 2002 according to history, should be worth 5% more per year.
This is where there’s a great opportunity for every home buyers in today’s market. If the price of a home today is at 2002 values because of over-correction there’s a significant amount of unrealized appreciation that the buyer could realize. Consider the $200,000 example below with a 5% appreciation per year.
2002 – $200,000 2003 – $210,000 2004 – $220,050 2005 – $231,500
2006 – $240,300 2007 -$ 255,000 2008 – $268,000 2009 – $281,000
2010 – $295,000 2011 – $310,000
Based on the above chart, a house that was selling for $200,000 in 2002 should be selling for approximately $210,000 based on historical appreciation. That same house today is only selling for $200,000 (back at 2002 prices). When real estate in the economy recovers it is very likely that the buyer will realize the appreciation delayed by the great recession as follows:
$310,000 (expected value) – $200,000 (recessionary purchase price) = $110,000 (hidden equity)
In other words, a buyer purchasing for $200,000 today could have $110,000 worth of hidden equity if they buy today!
It may take 5 years but at some point this $110,000 extra appreciation will be available to the buyer.
This is a tremendous windfall for today’s buyers. Even if the buyer overpaid by $20,000, they would still have over $80,000 worth of hidden equity.