Did you ever stop to consider what your house means to you? Do you see it as an investment, or simply a place to reside and raise your family while hoping to earn enough money to make the monthly mortgage payments. Have you ever seen it for what it really is a commodity? When looked at this way your house is no different than common stock or corn futures governed by the same economic principles that will cause its price to vary from one day to the next. The only real difference is the amount of time it will take for the housing market to respond to the factors that influence its price.
What is it that causes your home to have value? The obvious answer is and always will be how much demand is there by potential buyers of your home. Think of it a like selling art. Its selling price is determined solely by what others will pay for it. If the art looks as if it were scrawled on the back of an envelope, you will have few buyers. Conversely, if the art has mass appeal, much like the famous Currier and Ives prints seen so frequently on classic Christmas cards, then there will be more potential buyers.
The greater the number of potential buyers the greater the demand there will be for your home. If you are located in a town with a strong local economy, where businesses are expanding and everyone is experiencing an increasing standard of living, there will be greater demand for housing as more job seekers move to the area in an effort to participate in the local prosperity. If you are one of the lucky homeowners in the community, the increasing value of your property is a direct result of its demand. From this example you can easily see that the value of you home has nothing to do with what it cost to build, but rather the number of potential buyers. The greater the scarcity of appropriate housing, the higher the sales price. This is the very reason a home in Lincoln, Nebraska is priced less than a home of comparable size and construction cost in Boston, Massachusetts.
Just how high a price can you place on a home before no one will buy? Let us look at the situation that has existed in most of California and south Florida. For this example, we will say a typical family wishes to buy a home in California. In the current market it is quite common to pay $450,000 or more for a 1,300 square foot bungalow. If the buyer were to purchase this small house and finance 95% of the purchase price ($427,500) using a 30-year, 6.125% mortgage their monthly payment for principle and interest alone would be $2,453. Since most mortgage underwriting limits the maximum monthly payment a homeowner may make to 28% of gross income, the buyers must have a combined annual household income of ($2,453 x 12) / 0.28 or $105,151 without taking into account taxes and insurance. And just what percentage of California households have this kind of income? Fewer than 10%. This is not to say there are no individuals who desire to live in the area. Rather, it is simply the number of individuals who are able qualify for financing to purchase property that is limited.
As housing prices increase, the fewer families are able to secure the necessary financing. This situation has spawned a whole group of mortgage programs designed to permit more individuals to qualify for larger mortgages allowing the purchase of these higher priced homes. Mortgage programs that have emerged vary from numerous types of adjustable rate mortgages to those that during times of higher interest rates result in payments which are less than the amount required to pay only interest. The risk of this type of mortgage is that it creates greater debt for the homeowner. Many of these mortage programs effectively cause the homeowner to gamble on creating home equity through appreciation without any debt retirement. This is a good bet when the demand by potential qualified buyers is larger than the supply of available houses in the market, but what happens if there is either an increase in mortgage rates or even worse an economic downturn in the local or national economy.
As interest rates for mortgages increase, fewer prospective buyers are able qualify for the a mortgage. As the number of qualified buyers becomes smaller, home owners must reduce the cost of their house in an effort to sell. Those who remember the when Jimmy Carter was President may also recall that the Federal Reserve Board during the 1970s caused mortgage money to be loaned at interest rates in excess of 14%. During this period many homeowners discovered that if you could sell your house it was usually at a loss. The price of housing was almost in a freefall because the number of individuals who could qualify for a mortgage was so small in relation to the large quantity of houses for sale. Supply had exceeded demand creating a buyers market. While this does not compare to the minor increases experienced recently by the mortgage industry, it does point to the reason home prices have been reduced in most overheated housing markets.
Now that you have the basic economic fundamentals of supply and demand, what do you do if you currently live in one of these formerly hot markets. The answer is very simple. TAKE THE MONEY AND RUN! In investment circles this is called profit-taking. However, remaining in the same market requires you to re-invest your profits returning to the same financial position as you were before. Hence, my recommendation is to consider seriously the advantages to relocating to a city where both housing is more affordable and it is possible to enjoy the same or better quality of life. I am not going to recommend you move to the middle of the Mohave desert, but rather to a location the value of housing is appreciating. Just as anyone with a sound investment strategy, your simple goal is to sell high, take your profits and buy low with the reasonable expectation that you will again be able to do it again.
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Tim Butler is responsible for relocation with Hallmark Real Estate. To view all home listings in the in the multiple listing service (MLS) for Raleigh, North Carolina see http://www.HallmarkRealEstate.com
