The Theory of Recaptured Equity

Everyone knows that  Real Estate Markets  nationwide have suffered economically devastating losses over the past several years. Depending on the market, home prices have declined from 33% to over 50% of value from the highs reached during the 2005-07 boom years. The S&P Case-Shiller Index shows homes prices nationally have dropped to 2003 levels (See chart below). Some markets, such as Atlanta, Cleveland, Detriot, and Las Vegas have dropped to 2000 levels.

This trend is inconsistent with what has occurred for over 30 years with Real Estate, where according to the National Association of Realtor’s, prices generally increase approximately 5% per year. Using the 5% as a guide, prices should have increased 55% in the past 9 years, or since 2003. This means that a house selling for $100,000 in 2003, should be selling for $155,000 today. That’s $55,000 or 55% less than what it’s selling for today.

So, what happened to the $55,000 or 55% increase that should have occurred?  Is it appreciation that won’t happen because of the Great Recession and Housing Bubbles, or, have Housing Prices over-corrected?   Understanding the fundamentals of housing appreciation, is a simple matter of Supply and Demand. The more people that want to buy, the more likely prices will increase. The more inventory available, the more likely it is that prices will drop. There are many factors that affect supply and demand which will be discussed in the future. But, perhaps the two most compelling reasons for housing appreciation have to do with

1. Increase in the population– According to the U.S. Census, the U.S. adds 3.3 million new residents per year. They have to live somewhere. If the housing inventory is limited, residents must outbid their competition to either rent or buy. We all know that if a buyer can sell for more, or a landlord can get more rent, they do.

2. New Construction Costs/Replacement Costs– Residents being added to the population of an area every year must live somewhere, so new homes must be built. Builders must be able to turn a profit, so prices rise based on costs associated with labor and supplies. They both increase similar to the rates of inflation. As the costs rise, so does the cost of the home.

Now, back to the 5% annual appreciation. Both of the basic reasons for gradual appreciation still apply. Because they do, we should at some point in the future “Recapture” the $55,000 in lost appreciation. Keep in mind, that at some point in the very near future, we must start building again. When we do, prices must go up because builders won’t build unless they can make a profit. ‘

The “Recaptured Appreciation” may not happen all a once. But, as the economy recovers it most likely will happen within the next 5-10 years with appreciation of possibly 10% per year. The excess appreciation over and above the 5% may not start until local economy’s recovery and inventory levels return to normal. Once they do, it is very like excess appreciation will occur until the 5% appreciation is “Recovered”.

If you’re a homeowner or are thinking about buying a home today, and want to see how the Theory of Recaptured Equity affects you, open the attached spreadsheet. You need only click on the top box with the $100,000 and replace it with the actual price of your home or the home you are buying. The spreadsheet will calculate what the value will be once the market has recovered. (Notice that the price you pay today could double by 2016 with a market recovery- Now, that’s a great investment!)