Why is Value so Volatile? An Appraiser's Perspective.

First Concept: Cost

$510,000
$2,300
$436.17
$150

What do these numbers have in common?  They all have to do with "cost of living". 

• $510,000 is the price someone paid for that vintage bungalow in North Berkeley. 
• $2,300 is the standard rental rate for a 3 to 4 bedroom home in the Bay Area.
• $436.17 covers the monthly food expenses for a typical college student
• $150 is the monthly amount paid for a daily Starbucks indulgence.

These are what we call costs.

Second Concept: Value

But what is the value of something? To appraisers, value is typically determined by "the market".  This is accomplished by analyzing recent sales of arms-length transactions, which in laypersons terms means "how much regular people have been paying for similar houses".  This very concept of value is the foundation of what has been so chaotic in the housing market in recent years.  Since 2002, housing values have been volatile. First, housing values soared unpredictably, spurred by late 90s and post-911 relaxation in lending regulations combined with increased demand for home-ownership. Then, housing values crashed (unpredictably for some, not-so-much for others), spurred by the fact that people had bought homes they simply couldn't afford. Extreme value volatility is unusual, especially in the housing market. Market values are supposed to increase gradually over time, after years of work in paying mortgages and sinking money into maintenance and upgrades.  They should rarely decrease, given that there are always more people than available houses in a growing population. But, nowadays, the whole concept of value is changing as people are realizing that nothing is impervious to upheaval.

DUST

So, while value itself may be unclear right now, let's look at what value is not:

• value is not the cost of something.
• value is not always what you would pay for it.
• value is not permanent.
• value is not independent.

While the first three concepts are fairly obvious, the last might be a little mysterious to some.  What do I mean by that?  Well, in appraiser-speak there are actually four components of value (Yes, here is it, the secret code of appraisers.): DUST.

Really?

Yes.  DUST.  Dust is Demand, Utility, Scarcity and Transferability. These are the things that inherently make up value. They must be known and appreciated for they govern all that we see in our economic world!  They are the Four Sisters of Economic Fate.  Demand must exist to create value, obviously, and with it purchasing power (this is called effective demand). If the price is so high that no one can afford it, it essentially removes value. Yes! This is exactly what happened when people caught on that there was no way their entry-level office job salary was going to pay for a $6,000 a month mortgage! 

When the smoke cleared after the financing magical act, there was basically no purchasing power for these overpriced homes. This removed the demand component and led to this crash as we now see it.  Utility has remained essentially the same, houses are still used mainly for shelter or for income.  Transferability simply means whether the title can change hands or not.  This is usually not a problem unless the title is clouded with liens or intricate ownership chains. Scarcity, however, changed as a result of decreased demand. Suddenly, there was no buyers for properties and houses were foreclosing at a shocking rate. The market was flooded and there was no scarcity anymore. In fact, the foreclosures really pushed values down further than ever due simply to bringing so many more available houses onto the market.

Perpetual Volatility?

So, what is keeping the housing market so volatile still?  Values crashed, so shouldn't there be demand again?  Well, yes. And, actually, demand did increase and helped to bring some stablity to the market in 2009-2010.  This demand was fueled by low prices, investor purchases of "fixer-uppers" and also by government tax credits which really lit a fire under people to buy a home. Although low prices and investors still exist, the tax credits do not and their absence has led to a lot less activity over the past six months.  So, demand really isn't where it should be yet.  People are still scared of value volatility.  They are no longer seduced by tax credits. And, most importantly, there is still a lack of effective demand due to high levels of unemployment and much, much stricter lending regulations. And, there are still foreclosures coming onto the market which isn't helping increase scarcity. Yes, the four sisters of economic fate are continuing to cut old patterns in our system.

Silver Linings Are Priceless

However, there are definitely silver linings out there for new potential home owners. And there are beautiful homes just waiting for these loving new owners.  Even though financing is strict, there are many creative ways to buy homes as more people are buying with friends and/or family and taking advantage of community programs (here is HUD's list for California).  I will be assembling more information on home-buying tips and programs in future blogs. In the meantime, think about what you value most in a home, or just in life, and start saving for it.  It doesn't take a credit card company to tell you that some things are priceless.