Myth Buster: Do Homes Really Increase in Value?
When it comes to making the best housing investment, bigger is not better.
This article is based on Sam Rashkin’s book, Housing 2.0: A Disruption Survival Guide. It is intended as a roadmap for high-performance builders to become the most successful in the industry.
Why is this article about housing appreciation for a Green Builder audience devoted to sustainable building? The simple answer is that a successful zero-carbon movement is too important to get the value part wrong. And although high performance is critical in new homes, it’s a small slice of the total user experience pie.
Housing is the ultimate consumer product, where we spend 70 percent of our lives, so a small slice is not nearly enough. Environmentally conscious housing professionals must be focused on the total user experience, driving value to ensure a successful zero-carbon transformation.
The Home Value Paradox
The best place to begin is to debunk the myth, “Homes increase in value.” That’s misleading. Like any other large purchase (e.g., cars, boats, RVs, furniture, etc.), the house itself depreciates as it becomes worn, out-of-date, and in need of repairs.
So why do home prices increase? It’s because of the land part of the real estate transaction.
Typically, land appreciates much more than the house depreciates. That’s because land becomes significantly more valuable as it becomes scarcer and landscaping matures. As a result, homeowners typically realize a net increase in the future total value of their property (see Figure 1).
Figure 1: Land appreciation greater than home depreciation results in net positive appreciation.
Note there has been an enormous double-digit spike in the housing appreciation rate since the pandemic, but that rate is not sustainable. This is because the gap between median home price to median household income has been increasing exponentially for decades, and has reached a crisis point (see Figure 2). This suggests that a huge land price bubble may be unavoidable.
Figure 2: The gap between median home prices and family income continues to widen. Source: The Federal Reserve
Net home appreciation rates are often substantially overstated, because they leave out significant expenses incurred from maintaining and updating homes. Although these improvements usually add to home value, research shows they recoup significantly less than their cost.
The Role of Location in Home Equity
The concept of land appreciating while the home depreciates explains why real estate experts recommend buying the least-expensive home in the best neighborhood to optimize return on investment. Let’s see how this works.
We’ll start by assuming a price split that is common for newly constructed homes—65 percent for the home and 35 percent for the land. In addition, we’ll assume land appreciates at 6 percent per year, while the home depreciates 2 percent, for a 4 percent net appreciation rate, aligned with the 25-year national average pre-COVID.
Using a $400,000 median price home for the U.S. in 2021 means $140,000 is attributed to the land, while the remaining $260,000 is attributed to the home.
A home buyer would get a substantially greater return on the same $400,000 investment buying a more modest house in a higher-value neighborhood (e.g., flipping the value of land to 65 percent and home to 35 percent).
This increases the value of the appreciating asset, land, from $140,000 to $260,000, and results in $117,000 greater return over the average 10-year term of home ownership. (See example 1 in Figure 3.)
Alternately, a savvy home buyer may carefully select a home in a development optimized for the community experience and realize an increased land appreciation rate of 8 percent (compared to a poorly planned community where the land only appreciates at 4 percent).
If the land accounts for 35 percent of the new home value, the $400,000 investment in a better community results in a $95,000 greater return (see example 2 in Figure 3).
This myth-busting clarification is the reason behind the often-repeated mantra in real estate, “location, location, location.”
Figure 3: Examples of higher return on investment by optimizing land value. Source: Author’s Prosperity Value Calculator Tool
Why Buy a Home That Is Sustainable?
But how does this value concept relate to sustainable housing? The march to zero carbon homes is critical for our planet and represents a certain future of the housing industry. Here’s why that train has left the station.
First, our latest national energy code, IECC 2021, is equivalent to a zero energy-ready enclosure that exceeds the requirements of U.S. Department of Energy Zero Energy Ready Home program. The environmental community needs to encourage all states to adopt this latest code.
As a great start, seven states and U.S. territories are already at various stages of developing and implementing zero energy codes, including California, Oregon, New Jersey, New York, Puerto Rico, and Washington.
In addition, a growing number of states have policies for establishing carbon-free electricity by 2045-2050, including California, Colorado, Maine, Nevada, New Mexico, New York, Puerto Rico, and Washington.
National policies may follow suit. It’s time for all housing professionals to get on the path to zero carbon.
Integrating great community experiences with sustainable developments that will stand the test of time is vital to the success of this movement. Sustainable housing professionals need to expand their primary focus beyond the home to best practices for the communities desired most by American home buyers.
This especially includes affordable housing developments. This segment of the housing sector can least afford an absence of attention to the appreciating asset, the land, because they are most in need of the increased value.
A framework for ensuring optimized communities is included in my new book, Housing 2.0: A Disruption Survival Guide. The key “Why,” “What,” and “How” elements for the Housing 2.0 framework are shown in Figure 4.
Figure 4: The Housing 2.0 Framework is used to optimize community value.
When a home buyer makes a poor choice that results in a bad community experience, there are only two options to correct it. One is to absorb the huge expense and burden of moving, and the second is to accept and/or rationalize the choice rather than moving.
I have observed the latter far too often. Thus, the “why” for the community experience is simple: Place matters. It really matters.
Community experience is about an opportunity for connection. It’s vital to be able to engage with neighbors at each individual’s preferred level of interaction.
It’s about the environment around us each day. We all want to live in places that are nurturing and aesthetically pleasing. And, it’s about confidence in a sound investment. A home is often the largest purchase of a lifetime, and it should be located in a neighborhood that proves to be a good investment.
The Community Experience Imperative
The “what” and “how” for delivering a great community experience are substantially linked:
- It’s essential to optimize desired opportunities for interaction. That is achieved with effective open spaces.
- Great communities optimize appearance, which is achieved through investment in high-impact quality features consistent with a targeted budget.
- It’s important to optimize persistence of a vibrant community, which is achieved with development tools that help ensure enduring value for all homeowners.
More than 20 best practices for executing this framework are provided in the book. The accrued cost savings and added value tabulated in Housing 2.0 are shown in Figure 5 and add up to hundreds of thousands of dollars per home. Sustainable home design can no longer be divorced from community design and planning.
Figure 5: Accrued cost savings and added value optimize the community user experience.