Article: A Little Thing Called Value

The S&P Case-Shiller home price index released it's latest report on Tuesday.
First the good news. A small price increase did happen over the last four months.

Now for the bad news. Counter-balancing this moderately hopeful news was data showing that homes decreased a little over four percent from one year ago. Since 2006, when homes hit their peak value, the price drop has been a disconcerting 31%.

Gulp! That price decline means a house purchased in 2006 for $200,000, is worth about $138,000 today. Homeowners can feel the money slipping right threw their hands. Even with a 20% downpayment, the loan to value bankers analyze each time consumers get a loan, went from 80% at purchase to roughly 107%.

But what does the tremendous drop in value really mean? The whole subject seems to be rather distant, and yet, not so removed at the same time. After all, $200,000 could not be found in the walls, closets, nor basement at the time of purchase. What about the money spent on a new deck and would floors? Where did that go?

Ok, so how does this value thing really work? Let me go through an example a little removed from housing. For dinner tonight, I decide I want a nice strip steak. I go down to the local butchers and buy a great piece of meat for $10.95 a pound.

Dinner was so good that night, that I go back three days later to get more steak so I can freeze it. But now the same steak is now $8.95 per pound. The butcher tells me he received a larger than expected shipment yesterday and wants to sell it as fast as possible. I purchase two more and store them in the freezer. Just for grins, I go by the local butcher two days later to see what the price is and much to my astonishment, the same steak is now $6.95 per pound. Now I am upset! The butcher explains that a local newspaper published an article about mad cow disease. Demand for meat when down to nearly zero. He could not give it away to his customers.

Meanwhile, I lost money. If I kept the first steak I bought for $10.95 per pound and sold it immediately, I would have gotten the same if not slightly higher price. Now I would be lucky to sell it at all!

It suddenly dawns on me that the value of the steak depends on what other people like me are willing to pay, not the actual price on the package. The mad cow disease scare slapped the value all the way to near zero.

Getting back to housing. The home bought in 2006 for $200,000 was the going value then. No one could foresee the mother of all mad cow disease scares that ended the myth that homeownership is an investment. The value lost in the house is added to what was paid for the new deck, wood floor, and mortgage payments.

Make no mistake, a home is only a place in which we all live and enjoy. It's not an investment by any definition. Even if you pay cash for a house, and it appreciates, the gain is offset by inflation, opportunity cost (where the money could have been invested for a return) on the cash used to buy the home, money spent on improvements and repairs, and taxes when the property is sold (sales and possibly capital gains).

I know this view of home value runs counter to everything we have been taught for generations. Yet even in the best of times homes were never an investment. A house is different from a rare painting or a collectible car. It also has no liquidity. Even when demand returns, there are very few reasons why a house should continue to grow in value.

Now that I have you reaching for a bottle of wine or a good vodka drink, let's look at what really matters. You own a house, it's yours for as long as you want. Memories and families are created there that will last a lifetime.

And those bankers that stay awake at night, worrying about decreased home values, it's time for a different approach. When a consumer buys a house, it either appraises or not. After that, if a homeowner wants to refinance, eliminate the loan to value calculation. Put more weight on income, assets, and credit. Eliminate cash out refinances. Just give it a try and see what happens.