In a free market, prices contain valuable information. They can tell you about supply and demand in a given environment. They can sometimes indicate quality and value. And, of course, they can help you determine whether a purchasing or economic decision makes sense for your unique situation.
One of the first things you’ll study when shopping for a house is the price – and there are many good reasons for this. If a house is priced at $10 million, most of you reading this can immediately rule it out as a possible acquisition. If a house is priced at $5, you must assume that something is terribly, terribly wrong with it.
But unfortunately, prices are often misleading to new homebuyers.
Let’s explore why.
First, it’s easy to conflate price and value, but these are two entirely different things. We can illustrate this with a couple of intuitive examples. Many people possess sentimental items that fill them with nostalgia or warm memories; these objects wouldn’t fetch a high price at an auction, but they’re incredibly valuable. And at the other end of the spectrum, we have something like movie theater popcorn, which is pricey without offering much substantive value.
Housing prices sometimes work in similar ways. There are enough educated real estate investors out there to guarantee that prices function at least somewhat in line with objective value, but there are too many subjective factors in play to make this a certainty. Emotionally attached sellers may list their house at an unreasonably inflated price. You might be willing to pay much more for a house in a specific neighborhood or a house with a rare feature that’s very important to you. And there are plenty of low-priced homes that offer much more value than their listing price would imply.
Accordingly, price can’t tell you everything about a house’s potential value.
Two very similar houses can have very different prices. And the same house can fluctuate in price wildly from one month to the next.
These are just some of the superficial factors that can influence the price of a home, sometimes to an unfair or irrational degree.
Real estate comparables, or comps, are tools used by real estate agents and investors to evaluate whether a price is reasonable. In this process, the expert will look at several similar houses; they’ll look at houses in the same neighborhood, with a similar size and layout, that have sold in the past few months. If a new price is in the same ballpark as these historically realized prices, the buyer can be reasonably certain that the price is fair.
However, there are a few issues with this approach. Comps can find similar houses in terms of age, size, and location, but they struggle to tell you much about house conditions. They may also neglect important factors like aesthetics, historical relevance, or certain buyer priorities. In other words, these are a useful tool, but not a comprehensive one.
Next, remember that hidden issues can make a huge difference in the true value of a home. A house priced at $300,000 might ordinarily be reasonable, but if there’s a major foundation issue that makes the house unsafe to occupy, it might significantly reduce the value of the home. This is one reason why it’s so important to conduct a thorough home inspection before finalizing your purchase.
You should also keep in mind that home price and mortgage payments are totally separate things, and if you’re on a strict budget and you’re planning on taking out a loan, your monthly payments are more immediately impactful than the purchase price of the house.
As a simple example, if you have a loan of $200,000 at an interest rate of 8%, your monthly payments will be roughly $1,468. If you have a loan of $400,000 at an interest rate of 2%, your monthly payments will be roughly $1,478. With a low enough interest rate, you can afford to buy a house at a much higher purchase price without spending much more on your monthly mortgage payment.
Obviously, this doesn’t mean that you can ignore the purchase price of the home; if housing prices plummet, and you attempt to sell your house during this downward turn, you could lose a substantial amount of money. This point is purely meant to illustrate that a house price can’t tell you everything you need to know to make the right decision.
It’s also important to recognize that while historically, real estate has been a very secure and profitable investment, there’s no guarantee that prices are going to go up forever. There are certainly examples of neighborhoods and areas that suffer from depressed prices, and sometimes for many years. You can’t afford to buy a house with the a priori assumption that the price is going to increase in the coming years.
Real estate prices, and real estate decisions, are very complicated. That’s why smart homebuyers lean on experts to help them make the right decisions. If you’re in the market for a real estate agent, or if you’re just starting your real estate investment journey, contact us for a free consultation today!
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