I have developed a pet peeve in recent months, fueled by misleading articles that imply that a rise in average home price equates to rising home values.
While it is common for real estate professionals to alternatively use “average prices” when they mean “average values,” it is an altogether different thing to misunderstand the difference between the two.
Today I will step-up on my soap box and hopefully raise awareness for what I feel is a major ignorance in the real estate industry, and how the use of “average home price” by both real estate bloggers and mainstream media is totally misleading consumers about the current state of the housing market.
On My Soapbox About The Average Home Price
If the average home price in your Tallahassee neighborhood is on the rise, does that specifically mean that home sellers are getting more for their homes than they have in the recent past?
In other words, is there a correlation between real estate appreciation and the average home price in an area?
Many people assume so, but it is just not so.
And most people in real estate sales haven’t really thought this through, so they are quick to circulate reports that rising prices means that the housing market is no longer depreciating.
I will try to do my part is shedding light on this fallacy so that real estate agents will do the research necessary in their local market to determine value movements, regardless of where their average home price might be moving at the current time.
The Difference Between Average Home Price And Value
I believe the best way to illustrate the difference between average home price and average home value is through the study of anecdotal evidence, or stories of how the differences are really seen on the street.
Let’s take the case of the “Smith family.” Like the majority of Americans who are ready to buy a home, the Smith family plans on borrowing money to facilitate the purchase. Using a FHA loan, the Smiths plan on financing roughly 95% of their home purchase this month.
When the Smiths first started working with Century 21 Manausa and Associates on the internet in February, they used our mortgage qualification tools to get approved for a loan. The Smiths, much like most buyers, had determined a budget and wanted to ensure that they could purchase the right home and keep their monthly payments within a certain range (specifically $1,200 per month for the Smiths).
The Smiths were qualified for a $256,000 loan and decided to wait for the next school year to begin before selecting their home. They knew homes were still depreciating and they wanted to ensure they bought smart.
Now, here it is 8 months later, and mortgage interest rates have dropped. Keeping their same budget of $1,200 per month, the bank has notified the Smiths that they can afford a loan of $270,000. How exciting! They can spend 5% more ($14K).
The Smiths have gone out and selected the best value in the market for $284,000, allowing them to stay within their budget but get as much home as possible.
Interest Rates Impact The Average Home Price
So how does the Smith family experience shed light on the difference between average home price and average home value?
The Smiths were faced with a change in interest rates. They had a decision to either spend more money, or lower their monthly budget for housing. Like most people I have seen in this situation, the Smiths chose to get “more house for the money.” They chose to keep the same budget and take advantage of a stronger buying power. Simply put, they moved up the real estate market because of this stronger buying power.
Do you think the Smiths chose to spend $14K more on a home they could have purchased, or do you think they bought a nicer home? That’s right … they (like the majority of other families in America) chose to purchase a nicer home.
Now if the majority of home buyers are taking advantage of this strengthened buying power and are spending more money (without raising their monthly budgets), won’t the “average home price” be on the rise?
This doesn’t mean that values are on the rise though, right?
Supply And Demand Determine Home Value Changes
Home value movement will be tied to supply and demand.
If the supply of homes in the Smith family price range is too low, values will rise, right?
Well in Tallahassee, we have more than 10 months supply of $280K homes for the Smith family to choose from, so we know that average home values are still declining. In fact, it is highly possible that many price points are showing a rise in the average home price, while showing a decline in the average home value.
So if you have that the Smith family might like, you have to ask yourself “what is my home worth to them, not to me?”
The moral of the story is this:
The change in average home prices are due to the buying power and posture of home buyers, whereas the change in home values is due to the relationship between supply and demand. Over the long run, home values and home prices should generally move in the same direction, but in the short run, it is quite possible for them to move in opposite directions. If you want to know whether the market is appreciating or depreciating, you have to look at home value trends, not average home price trends.
So, make sure you confirm that home values are really rising or falling in your market, don’t simply rely on the garbage that NAR spouts relating to the changes in the average home price.
I expect that the average home price in most markets will be rising based upon historic low interest rates. People are getting more home for the money and they are happy keeping their budget stable in this tough economy.
I also expect that the average home value in many markets will be continuing to fall, based upon the fact that there is still a large inventory of distressed homes for sale. This “supply” is larger than the current demand in many markets, thus values are falling.
And if you want to know more about the value of your Tallahassee home, just drop me a note and I will help you understand both average home price changes as well as home value changes for homes like yours.