I don’t know how many times I have heard that the most important element underlying the value of real estate is location. Location, location, location!
It is true; 4 acres on the beach in Del Mar is likely to be worth more than any 4 acre parcel in the San Diego County backcountry. However, with respect to any given parcel in and of itself, I would argue that timing is at least important as where the property is located. As I frequently say, you can own the Taj Mahal and in a down market not be able to sell it. As I see it, location represents the primary spatial component to value while the timing of ownership is, obviously, the primary temporal component to value.
As a matter of real estate practice, an appraisal is typically used to establish the value of a particular property on a given day; a snapshot of what a willing buyer might pay for the property based on what other properties most similar to the subject property have sold for.
I am much more interested in how the value of a given property is trending. From where has the value come; at what rate of change is the value moving; and, of course, in what direction?
A “snapshot in time” provides a value for a moment in time. The truth of the matter is the value could be ready to fall off of the table. For example, the value of an average single family residential home in the San Diego County backcountry community of Julian sold for about $445,000 in 2007, backing off a peak high of nearly $460,000 in 2005. In 2009, the same house sold for $210, 0000. Four years is not a long time to own a home. That is about how long it takes me to settle in.
With a little effort and knowing the right questions to ask, a novice could have seen the decline in home values coming. I did not anticipate a drop in values of the magnitude we have experienced, but a significant decline, or correction in the market was inevitable. It is an established fact that real estate values are cyclic. The dynamic involved is a simple economic concept: when demand outpaces supply, prices rise; when the market is oversupplied, relative demand is diminished and prices recede. Picture two kids, one named Supply and one named Demand leap-frogging one another and you will have a good idea of the interplay between not enough and too much housing. Add innovative monetary policies, such as the absence of common sense in the credit markets, and you can then picture the kids playing on a green grassy slope heading down the hill. Supplement this picture with unfettered greed and the picture changes to the kids on a rocky slope tilted beyond the angle of repose. The good news is that there is always a bottom – some are more painful to land on than others, which is a function of the distance between the value peak and the valley floor.
The charts below illustrate the cyclic nature of the value cycles of the stock market and the real estate market in San Diego County. Notice that the real estate value cycle and stock market value cycle mirror one another.
100 Year History of the Dow Jones Industrial Average
One trend lost in the details is the overall increase in the valuation of both stocks and real estate. You can attribute this phenomenon to another economic principle: economic expansion. Simply explained, for this trend to continue, the population of consumers will need to continue expanding. More people translate into more demand and rising values.
The trick in real estate is to learn to ride the wave – not to get rich quick, but to keep from drowning. If real estate contributes significantly to your financial portfolio, understanding and anticipating the alternating rise and fall in value of your real estate should be an essential skill to develop in order to avoid relying on the self-serving opinions of others. The most recent trend in reals estate reveals about a 15 year period from peak to peak (or valley to valley). I don’t mean to imply that we will be peaking in 2020, if we consider 2005 to be our most recent value peak. I am suggesting that one pay attention to the rhythm of real estate values and make the necessary adjustments in managing your holdings in light of the inevitable ups and downs that come with the landscape. As long as our population continues to expand, real estate values will probably once again rise and fall – just as predictable as the waves in the ocean. If you want to enjoy a pleasant ride on the value wave of real estate, my advice would be to consider the timing of your real estate moves first!