Profiting from house price appreciation requires getting more money from the sale of a property than was originally paid for it and not having that profit cancelled out by moving costs, transaction fees, and a large spreads between the cost of ownership and the cost of rental during the ownership period. Buying and selling residential real estate incurs significant transaction costs that are not reflected in the price. It is quite common for properties to sell for more than their purchase price and still be a loss for the seller. However, even if the seller loses money, the realtor gets a commission. Six percent of an owner’s house price appreciation goes to paying the realtor.
The portion of investment value caused by appreciation can only be evaluated by an accurate estimate of appreciation during the ownership period. The general public grossly overestimates the rate of home price appreciation. Historically, houses have appreciated at a rate 0.7% over the long-term level of inflation. From 1983 to 1998, a period of low inflation and declining mortgage interest rates before the housing bubble, the rate of house price appreciation was 4.5% nationally which was 1.4% over the rate of inflation. Appreciation rates are tied to income and rents because this is the fundamental value of residential real estate.
When people purchase residential real estate they pay numerous closing costs including title insurance, recording fees, document stamps and taxes, mortgage application fees, survey fees, inspection fees, appraisal fees, et cetera. These fees often total between 2% and 4% of the purchase price not including any prepaid interest points on the mortgage.
When people go to sell residential real estate they generally go to real estate broker who will charge them a 6% commission. There has been an increasing popularity in the use of discount brokers, but the National Association of Realtors has done a remarkable job of keeping brokerage commissions at 6% despite market pressures to lower them. These transaction costs are part of every residential real estate transaction, and they take a substantial portion of the profit on properties with short holding periods, and if the holding period is not long enough, transaction fees create losses.
Due to the high transaction costs, a property does not reach breakeven until two full years of ownership. In a discounted cashflow basis, a property does not break even until after 4 full years of ownership. It is these high transaction costs that compel many with short-term housing needs to rent rather than own.
Realtors like property flippers and people who move frequently because it provides them opportunities to extract 6% out of a large transaction. The higher the sales volumes, the more money they make. If not for home price appreciation, there would probably be a national revolt against these high commission rates, but since houses generally appreciate enough during a typical ownership period to cover the commissions, the populace simply accepts these outrageous fees as normal and acceptable. Perhaps the housing bubble will change that.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
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