Snarky Behavior


December 2, 2008 · Leave a Comment

I remember in college, I used to watch a show called “House-Flippers” or something like that.  The premise was: some realator would go around buying up houses, do minimal renovations, and “flip” the house for profits of $30-100k.

Last week I watched a similar show, only the premise was different.  Instead of speculators “flipping” houses, it focused on homeowners trying to increase the appraised value of their home so that they could either refinance their mortgage and keep the house, or qualify for a home equity loan to pay down some other liability.

The environment now is so drastically different!

Still, I was shocked at how “valuation” takes place on these shows.

For instance, one couple spent something like $10k to completely renovate their garage into a master bedroom.  They did all of the work themselves, and saved a bundle in labor costs.  At the end of the day, they had an appraiser come in and re-evaluate the home, and he claimed that he would list it on the market for like $70,000 more than before.

People still don’t seem to understand the word “value” in “valuation.”  If I do $10k worth of renovations to a house, the house is logically $10k more “valuable.”  It may be worth more based on how much I value the time and labor costs of the renovation, but it certainly isn’t suddenly $70k more valuable.

Part of the confusion boils down to people buying into the idea that a home is an investment.  An investment is a good that expects to produce a return to the investor.  For instance, if I buy a house, I COULD sell it in the future for an appreciable return.  But what is a house?  It’s a building on a piece of land, that typically “lasts” 50-100 years.  After that, the thing starts falling apart… the pipes rust, the wood rots, the bricks crumble.

The fact that a house “breaks down” or deteriorates over time means that houses should logically be seen as DEPRECIATING INVESTMENTS.  Therefore, house values should logically increase over time ONLY at the rate of inflation, less any depreciation costs, unless significant repairs and/or restorations have been made along the way.

Any increases in house value besides inflation can be attributed to one of three things:

1.)  Real increased consumer demand (i.e. influx of immigrants, new generational wave of homeowners, etc.)

2.)  Real decreased producer supply (i.e. fire/flood/earthquake destoys housing stock)

3.)  Rennovations/restorations on/of the property

Now, as consumers, we have very little to go by in terms of measuring “real” consumer demand, and only a bit more in terms of measuring the “real” available housing stock.  We use the price as the indicator of the market, but what is included in that price?  Let us remember who has an interest in seeing that price high:

1.)  The seller, who wants a profit

2.)  The realator, who works on percentage commission

3.)  The banker, who also works on percentage commission, and can squeeze higher rates on higher principals that imply “riskier” loans.

4.)  Other home-owners, who measure their wealth and net-worth based on the perceived market value of their own home and equity therein.

The information provided to a consumer in the housing market is SO DISTORTED.  Not only are people watching shows where appraisers come in and “ball-park” ridiculous sums (do we forget who realators are?  They are mostly stay-at-home or part-time moms with Associates’ Degrees at best… and we’ve allowed them to “divine” the demand curve?), but they are being led by the hand by third-party brokers who work on commission, and financing their purchases by seedy lenders who artificially inflate the income constraint (and thus, the price) on all other parties by providing easy money.

Hind-sight is 20-20, but it’s amazing how we let that monster of a bubble build on itself.  And if the show I just watched on HGTV is any indicator, people still don’t get it.  There is no “rule” saying houses should increase in value over time.  Indeed, when adjusting for inflation, logic implies the opposite.

A home isn’t an investment to be upgraded and “flipped.”  It is a building to be lived in.  It’s value is providing shelter to its inhabitants, in proximity to schools, safe neighborhoods, and places of employment.  There’s no “law” that guarantees a house can be a “nest-egg,” that the equity will earn a return over time.  And a garage turned into a master bedroom just means that former 2BR/2B/G at $750k is now a 3BR/2B at $780k… and you’d better have street parking somewhere.

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