Is real estate appreciation a myth? Adjusting for inflation
Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
Is real estate appreciation a myth? Adjusting for inflation
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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
4y37% of the inflation index is a housing component, and the largest component of the index. So essentially rising real eatate prices are the definition of inflation.
Real estate isn't purchased at a steady position however. It is typically purchased at a leveraged position. So of you are at a 4-1 leveraged position (20% down, 80% LTV), then you out perform inflation by a factor of 4, before even counting in rent or debt pay down. If you bought in at 3% down, you are at a 33.33-1 leveraged position and you beat inflation by a factor of 33.33 times...or a return of 3,333% per year versus inflation.
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- Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes4y
@Eric James In answer to your last question, the local rate of inflation, as measured by census data, confirms my point.
The median household income in Marin County CA went from $13,935 in 1970 to $89,268 in 2010. In 2020, the median household income leapt to $121,671. Based on CPI, the ambient rate of inflation would have put the median at $93,151 in 2020, so incomes had exceeded CPI inflation at that point in time by a total of about 30%. The median price of a home in 1970 was about $32,000 - $213,452 in inflation-adjusted terms as of 2020. This was about 25% above the California median. The median house in Marin stands at $1.5 million as of April 2022 per realtor.com.
We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI).
- Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Account Closed:
Quote from @Justin Colletti:
Real estate often does outpace increases in the CPI yes, but that's not the same thing as "inflation", at least by the better, classical definitions of the term.
For an improved view of the picture, compare the cost of the median US home to other assets. For example, the price of gold, the price of stock indexes, the price of commodities and so on, and you will find that despite the recent nominal increases, US real estate is actually closer to its historic lows than its historic highs.
Here's a chart that is particularly telling in my view: The Case/Shiller housing index relative to gold. It tells a similar story to the chart shared earlier of the Shiller index relative to M2 and income, but even better in my opinion, as average wages can also fluctuate in real value:
Here's a closeup of the past 60 years or so:
A confounding factor here is that although home prices are actually down in real terms, rents and wages are also down in real terms compared to historic highs.
Another way to look at things is that the dollar has lost so much value, compared to gold, that it appears prices have gone up. It's true that it takes more "dollars" but is simply screaming that the dollar is now worth so much less.
Real estate takes maintenance, replacements, property taxes, insurance and other costs. Physical gold does not.
When we bought our first house in Seattle in 1986 it cost the equivalent of 242 ounces of gold. Interest rate was 8% by the way. Today it is valued at 781 ounces of gold. That my friend, is actual appreciation . . . or a gigantic bubble.
It doesn't take into account the total remodels, taxes, payments and improvements over that period and cost of sale if you liquidate. And, if Amazon & so on, had moved to Kokomo Indiana instead of Seattle, the property would be worth far less. That is something you can't control and can't plan for.
Great reply @Account Closed!
A couple things to note here: Yes, there are parts of the country where property values have increased substantially, even in terms of gold or other assets that do a better job of approximating true monetary inflation than the CPI does. But there are some big caveats here, one of which you have noted:
1. You mention how much work you put into the home to realize that appreciation in real terms. Great of you to point out! I don't know how much work you did, but it's possible you even improved the quality or size of the house from where it started. In any case, looking simply at the before an after value does not factor this in.
2. There are areas where property values do appreciate in real terms... But this isn't because of the house itself increasing in value. Rather, it's because the property on which that home sits is now experiencing higher demand! You still have a house that's a depreciating asset. But that is offset by increased demand for the physical property upon which it is sitting. Magically transport that house to somewhere else where demand hasn't risen and you will see it has indeed depreciated in value relative to when it was first built, all else being equal.
3. In those areas in the country where the underlying property may have appreciated in real terms, it certainly is possible there could be bubble dynamics at play. Places like NYC, San Francisco, Seattle etc., are among the most likely to experience that kind of thing. Some of their appreciation relative to other areas and relative to the national average may be relatively short lived. Many big cities have been through waves where they have been seriously overvalued and seriously undervalued over the years. NYC is a great example of this, but is not unique in this regard.
But to illustrate the larger point that the home itself is a depreciating asset—even if its price were to appreciate in real terms—we have to examine the possible "counterfactual" scenario.
Imagine a scenario where you had the same exact piece of property with the same type, size and layout of home, but in one example, the home was built in 1970, and in one example it was built in 2020. The newer home would be worth more than the old one. This would be true even if we could control for the quality and amenities of home at the point it was built! Even if the homes were identical at the outset, one has experienced wear and tear and the other hasn't.
This would still be the case if the home "appreciated" in real terms due to increased demand for real estate in that area. But it's fair to say that was appreciation of the underlying property due to increased demand. Not appreciation of the building itself, which is depreciating in the background, even as the market price for the property increases at a faster rate.
The only way you could keep this from being the case would be to invest a ton of money into that older depreciating home to keep it from depreciating further in real terms, or perhaps even increasing its size or quality from where it started. But again that's not really a fair comparison, because we're spending money to improve the property, so it's not really "appreciation". They are paid upgrades. Hopefully ones you made an investment return on, but also, maybe not.
Hope that makes sense! - Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms. - 4yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesIn the end, what does this all mean, in dollars?
Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms. - Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes4y
@JD Martin except that rates are still below historical norms….
- Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes4y
@Llewelyn A. Yup, most of us are I. The debt management business…real estate is just the medium
- Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms."in the end what does this all mean, in dollars?"
That dollars aren't the best thing to measure value with. Especially not over long periods. Better perhaps, to measure value with something that is more stable in value?
You can try to do this by measuring every asset against every other asset to see what their relative values are over long periods. That can be very instructive. If you do this, you will likely find that there is one asset that is more stable in value relative to all other assets over long periods.
Incidentally, it's exactly the asset keeps on getting selected as money—and therefore, as the primary unit of account—again and again throughout history.
This makes sense... Because it keeps on behaving this way, whether or not people use it as money. That's precisely why it works so well as money, and why it is inevitably selected as the base money again and again throughout history, every time it becomes obvious that all the alternatives just don't work as well.
(Spoiler alert: It's gold. But don't take my word for it. Do this analysis for yourself. I've yet to find someone who has done so and come up with any other recommendation for the most stable possible unit of account over reasonably long periods. Even a "basket of commodities" doesn't work as well, because every other commodity in the basket would be less stable than just using gold. And yes, gold is substantially more stable than dollars, especially over long periods.)
Long story short:
The best way to objectively value a property is by the cash flow it will yield. (That's what we're all here to do, right?)
The next best way is to value it relative to the most stable asset you can find over long periods. (That's gold.)
The next best way is to value it relative to all other real assets.
The next best way is to value it relative to all other financial assets.
The last best way is to value it relative to dollars. (This usually doesn't work too bad for shorter term analysis. But it makes long term analysis much more difficult, as the length of the yardstick keeps changing over time.) - Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes4y
@Justin Colletti actually the best way to value it—I submit—is what does the action of owning real estate allow you to do?
Live well or poorly according to your lights? Help others or be a burden?
The answers ultimately determine the value of your investment…cash return, appreciation, taz benefits are only chess (or checker) pieces used to reach that goal.
Are u better or worse off because you invested in real estate?
- 4yPaul MoorePro MemberCommercial Real Estate Fund Manager · Lynchburg, VA · Member since 2015 · 1k+ posts · 1k+ votes
Hi @Eric James. Great question and you got some wonderful responses above. I will add this into the mix...
Wall St. suffers under the Efficient Market Hypothesis. This theory is based on the fact that there are millions of eyeballs on assets and operators and the thorough analysis from a wide spectrum of players means that the price is exactly what it should be. In other words, it's very hard to get a bargain.
In real estate however, the market is incredibly inefficient which means that even if real estate is generally priced at a certain level, it is still possible to get great deals depending on the location, the seller and a hundred other factors.
Specifically, as a commercial real estate investor I like to look for operators that are experts at locating and harvesting intrinsic value. Which means potential value that is left on the table by prior operators. Typically, these are mom-and-pop operators who don't have the desire, knowledge or resources to improve the properties, increase income and maximize value. Acquiring assets like this or investing in them is another path to significantly outperform inflation. Happy investing!
- 4yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesIf you won't measure in dollars, why are you investing in ...anything? Of course dollars are the best, and in the end the only way to measure REI.
Quote from @Justin Colletti:
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms."in the end what does this all mean, in dollars?"
That dollars aren't the best thing to measure value with. Especially not over long periods. Better perhaps, to measure value with something that is more stable in value?
You can try to do this by measuring every asset against every other asset to see what their relative values are over long periods. That can be very instructive. If you do this, you will likely find that there is one asset that is more stable in value relative to all other assets over long periods.
Incidentally, it's exactly the asset keeps on getting selected as money—and therefore, as the primary unit of account—again and again throughout history.
This makes sense... Because it keeps on behaving this way, whether or not people use it as money. That's precisely why it works so well as money, and why it is inevitably selected as the base money again and again throughout history, every time it becomes obvious that all the alternatives just don't work as well.
(Spoiler alert: It's gold. But don't take my word for it. Do this analysis for yourself. I've yet to find someone who has done so and come up with any other recommendation for the most stable possible unit of account over reasonably long periods. Even a "basket of commodities" doesn't work as well, because every other commodity in the basket would be less stable than just using gold. And yes, gold is substantially more stable than dollars, especially over long periods.)
Long story short:
The best way to objectively value a property is by the cash flow it will yield. (That's what we're all here to do, right?)
The next best way is to value it relative to the most stable asset you can find over long periods. (That's gold.)
The next best way is to value it relative to all other real assets.
The next best way is to value it relative to all other financial assets.
The last best way is to value it relative to dollars. (This usually doesn't work too bad for shorter term analysis. But it makes long term analysis much more difficult, as the length of the yardstick keeps changing over time.) - Investor · Scottsdale Austin Tuktoyaktuk · Member since 2021 · 4k+ posts · 4k+ votes4y
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms.Well, in dollars it means this . . .
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 17k+ votes4y
Quote from @Jonathan R McLaughlin:
@JD Martin except that rates are still below historical norms….
Not sure how to respond because I'm not sure what this statement was in response to - can you elaborate?
Skyline Properties - 4yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesSo you don't know.
Quote from @Account Closed:
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms.Well, in dollars it means this . . .
- Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Joe Villeneuve:
If you won't measure in dollars, why are you investing in ...anything? Of course dollars are the best, and in the end the only way to measure REI.Quote from @Justin Colletti:
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms."in the end what does this all mean, in dollars?"
That dollars aren't the best thing to measure value with. Especially not over long periods. Better perhaps, to measure value with something that is more stable in value?
You can try to do this by measuring every asset against every other asset to see what their relative values are over long periods. That can be very instructive. If you do this, you will likely find that there is one asset that is more stable in value relative to all other assets over long periods.
Incidentally, it's exactly the asset keeps on getting selected as money—and therefore, as the primary unit of account—again and again throughout history.
This makes sense... Because it keeps on behaving this way, whether or not people use it as money. That's precisely why it works so well as money, and why it is inevitably selected as the base money again and again throughout history, every time it becomes obvious that all the alternatives just don't work as well.
(Spoiler alert: It's gold. But don't take my word for it. Do this analysis for yourself. I've yet to find someone who has done so and come up with any other recommendation for the most stable possible unit of account over reasonably long periods. Even a "basket of commodities" doesn't work as well, because every other commodity in the basket would be less stable than just using gold. And yes, gold is substantially more stable than dollars, especially over long periods.)
Long story short:
The best way to objectively value a property is by the cash flow it will yield. (That's what we're all here to do, right?)
The next best way is to value it relative to the most stable asset you can find over long periods. (That's gold.)
The next best way is to value it relative to all other real assets.
The next best way is to value it relative to all other financial assets.
The last best way is to value it relative to dollars. (This usually doesn't work too bad for shorter term analysis. But it makes long term analysis much more difficult, as the length of the yardstick keeps changing over time.)I'm not sure I understand the question Joe. If I use a better yardstick to measure my returns, it doesn't change the amount of returns I get. I still have the same returns. I just have a better measurement of them.
The underlying returns are the same, regardless of what asset or method you use to measure them over long periods.
Similarly, if we measure the height of a building using a wooden ruler or a rubber band, the actual height of the building is still the same. Using a better or worse measurement doesn't change the height of the building.
Same goes with valuing properties with gold vs dollars.
Hope that makes sense! - Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Jonathan R McLaughlin:
@Justin Colletti actually the best way to value it—I submit—is what does the action of owning real estate allow you to do?
Live well or poorly according to your lights? Help others or be a burden?
The answers ultimately determine the value of your investment…cash return, appreciation, taz benefits are only chess (or checker) pieces used to reach that goal.
Are u better or worse off because you invested in real estate?
That's absolutely a good way to look at it Jonathan!
I'd only offer that if your quality of life, or your ability to have more impact is your goal, then the best objective metric we have to help you evaluate that is how much headache vs how much cash flow you get out of the property! (The headache may be hard to numerically measure, but the cashflow isn't. :-)
As far as "appreciation", well that's the question we are trying to answer in this thread. And if you measure real estate properly—by comparing it against either its cashflows, or against another asset of relatively stable value—you find that on a national average level, housing doesn't really "appreciate" at all.
Houses and buildings are indeed depreciating assets. (Even though the land that they are sitting upon may see more demand over time in certain areas. And even though the dollars you measure them in may be worth far less over time.)
That said, they tend to depreciate at a rate significantly slower than the dollar does, so if you use debt wisely and buy well, you're likely to come out ahead, even on that basis alone.
...But that's not the house appreciating necessarily. That's the dollars you are paying back depreciating more quickly than the house.
I think it's good to look at the structure underneath things, and that's what's going on here.
Hope that makes sense! - 4yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesThe question is, when you arrive at an answer to a financial analysis, that is in %%%%, what does that tell you? If your goal is a number in $$$$$, isn't the answer in %%%% an incomplete answer?
Quote from @Justin Colletti:
Quote from @Joe Villeneuve:
If you won't measure in dollars, why are you investing in ...anything? Of course dollars are the best, and in the end the only way to measure REI.Quote from @Justin Colletti:
Quote from @Joe Villeneuve:
In the end, what does this all mean, in dollars?Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms."in the end what does this all mean, in dollars?"
That dollars aren't the best thing to measure value with. Especially not over long periods. Better perhaps, to measure value with something that is more stable in value?
You can try to do this by measuring every asset against every other asset to see what their relative values are over long periods. That can be very instructive. If you do this, you will likely find that there is one asset that is more stable in value relative to all other assets over long periods.
Incidentally, it's exactly the asset keeps on getting selected as money—and therefore, as the primary unit of account—again and again throughout history.
This makes sense... Because it keeps on behaving this way, whether or not people use it as money. That's precisely why it works so well as money, and why it is inevitably selected as the base money again and again throughout history, every time it becomes obvious that all the alternatives just don't work as well.
(Spoiler alert: It's gold. But don't take my word for it. Do this analysis for yourself. I've yet to find someone who has done so and come up with any other recommendation for the most stable possible unit of account over reasonably long periods. Even a "basket of commodities" doesn't work as well, because every other commodity in the basket would be less stable than just using gold. And yes, gold is substantially more stable than dollars, especially over long periods.)
Long story short:
The best way to objectively value a property is by the cash flow it will yield. (That's what we're all here to do, right?)
The next best way is to value it relative to the most stable asset you can find over long periods. (That's gold.)
The next best way is to value it relative to all other real assets.
The next best way is to value it relative to all other financial assets.
The last best way is to value it relative to dollars. (This usually doesn't work too bad for shorter term analysis. But it makes long term analysis much more difficult, as the length of the yardstick keeps changing over time.)I'm not sure I understand the question Joe. If I use a better yardstick to measure my returns, it doesn't change the amount of returns I get. I still have the same returns. I just have a better measurement of them.
The underlying returns are the same, regardless of what asset or method you use to measure them over long periods.
Similarly, if we measure the height of a building using a wooden ruler or a rubber band, the actual height of the building is still the same. Using a better or worse measurement doesn't change the height of the building.
Same goes with valuing properties with gold vs dollars.
Hope that makes sense! - Lender · Boca Raton, FL · Member since 2014 · 250 posts · 133 votes4y
You need to factor into it the leverage component. Example lets say prices increase at 5% annually. Also lets say you but a property for 100k and you put down 25k. You get the 5% increase on the 100k and your investment is only 25k.
- 4yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesNo, your investment is still $20k (I assume you meant 20k DP not 25K). The equity build up doesn't give you back your cash. The equity doesn't actually exist anywhere but on an accountant's paper. The money/cash you spent on the DP and the CF that recovers it, are both real money, and exists on "green" paper, as is usable now. It actually exists.
Quote from @H. Jack Miller:
You need to factor into it the leverage component. Example lets say prices increase at 5% annually. Also lets say you but a property for 100k and you put down 25k. You get the 5% increase on the 100k and your investment is only 25k.
When my accountant pays my bills using the virtual money from that accounting paper, then I'll count that appreciation as real money. Until I can spend it, I'll count it as virtual (and potential) money. - Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes4y
Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms.The question of how to measure inflation is a key part of this question. As Russell mentioned,, one issue is that real estate prices are included in the calculation of the CPI. Also, many think CPI (intentionally) underestimates inflation. Another problem is that the calculation of CPI has changed over the years. Using the 1980 CPI formula to calculate inflation yields a current inflation rate that is around 16%, rather than 8%.
- Keene, NH · Member since 2015 · 22 posts · 22 votes4y
Quote from @Eric James:
Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms.The question of how to measure inflation is a key part of this question. As Russell mentioned,, one issue is that real estate prices are included in the calculation of the CPI. Also, many think CPI (intentionally) underestimates inflation. Another problem is that the calculation of CPI has changed over the years. Using the 1980 CPI formula to calculate inflation yields a current inflation rate that is around 16%, rather than 8%.
Some of that is definitely right Eric! But it's even worse than that.
First, the commonly stated CPI statistics do not actually include real estate price increases. Rather, they use something called "Owner's Equivalent Rent". This is based on survey data about what homeowners THINK they would have to pay to rent their house if they had to rent it.
Many homeowners can be decades behind in their thinking about what their home might cost to rent, and this figure systemically and significantly understates actual upward changes in rents and home prices. But that's not all.
After that, you have to think about how home price or rent increases are weighted against other goods. Home prices and rents are a huge component of people's actual monthly expenses. Often, the largest part of their monthly expenses. And yet, the increases there are not really factored in as such into the indexes.
On top of this, there's the fact that the analysts make subjective "hedonic adjustments" to further downplay price increases that have actually occurred.
Yes, you are correct that if they used the methodology of the past, CPI increases would be at least twice of what it they are today. But even that understates the effect of inflation.
This still does not include asset price inflation, the amount of capital required to fund a retirement, and so many other factors. But most notably, it also doesn't factor in that most prices in the CPI would naturally fall—not rise—against a stable monetary baseline. So to do this properly, you'd need the counterfactual of how much prices would have fallen if there hadn't been any monetary inflation to begin with!
As written earlier:
"If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
"Yet that's exactly what some people try to get you to do.
"No, the inflationary price increase in that context was at least 22% relative to where it would otherwise be.
"And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even properly included in the basket of goods. (Oil, rent, education, stocks, medical care, home prices, etc.)
In reality, all of the natural lowering of our cost of living we might would experienced without the monetary inflation would need to be factored into these baskets for them to begin to make any sense. And even then, they'd still have too many issues to count.
Bottom line is that by the more sensible classical definition, inflation is when the currency is created. The exact consumer price dynamics are far too complex to properly index in this way, even if the people who print the currency had an incentive to properly index them—rather than having incentives to understate them instead. - Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes4y
Quote from @Eric James:
Quote from @Justin Colletti:
Quote from @Eric James:
One stated benefit of investing in real estate is price appreciation. However, if you look at inflation adjusted real estate prices for the most part there isn't much appreciation. There are specific points in time like 2006 (we know what followed that) and right now when real estate exceeds inflation adjusted prices. However, over the long term it doesn't really appear that real estate appreciates much beyond inflation. Is real estate appreciation a myth?
"We can debate whether this is a better investment than x but as to the initial question you posed, there is no doubt that growth in this market has clobbered the rate of inflation (as measured by CPI)."
And therein lies the rub. As detailed elsewhere in this thread, the CPI does not measure the rate of inflation. At least not by any sensible or classical definition of the term.
Rather, it captures the prices of a limited basket of consumer goods, which are likely to see naturally falling prices in real terms due to increases in productivity, improvements in technology, outsourcing of labor, increased capacity and so on.
If the price of a fixed basket of goods would have dropped 20% against a stable monetary baseline, but instead its price rose by 2%, it would be crazy to say "Well, inflation was only 2%!"
Yet that's what some people try to get you to do.
No, the inflationary price increase in that context was 22% relative to where it would otherwise be. At least.
And that's before we factor in substitutions, hedonic adjustments, and the fact that goods, services and assets that experience the greatest inflationary price increases aren't even included in the basket of goods. (Oil, rent, education, medical care, home prices, etc.)
This is why the classic definition of inflation is far more sensible. Inflation is when they create the currency. The price dynamics that occur after this are an entirely separate can of worms.The question of how to measure inflation is a key part of this question. As Russell mentioned,, one issue is that real estate prices are included in the calculation of the CPI. Also, many think CPI (intentionally) underestimates inflation. Another problem is that the calculation of CPI has changed over the years. Using the 1980 CPI formula to calculate inflation yields a current inflation rate that is around 16%, rather than 8%.
@Eric James Housing prices are not part of inflation. The calculation uses rents and owner occupied equivalent rents.
- Rental Property Investor · Lehigh Valley, PA · Member since 2017 · 200 posts · 191 votes4y
Doesn't inflation push up prices?
- Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes4y
Quote from @Michael Deering:
Doesn't inflation push up prices?
Yes and no. And it varies over a time scale.
The most immediate impact from inflation on housing prices is "Compression", where lower strata of prices go up at a disproportionate rate and higher strata lowers.
At higher strata higher interest rates consume purchasing power, and at lower strata due to buyers lowered capacity to purchase more are pressed into lower price points, driving up demand, as well as shifting buyers into delayed purchase ability better known as "renting".
This is the more short-term effect. Long term, as it effects cost of housing inputs, yes, then the higher strata springs up as inventory washes out and is more connected in pricing unto replacement cost as the cost to build has been pressed up by the inflation.
- Investor · Philadelphia, PA · Member since 2015 · 69 posts · 28 votes4y
In our financial system, monetary inflation and asset appreciation are related. Assets purchased at one point in time appreciate over time compared to the value of money over the same time period. Since nothing exists in a vacuum, it's hard to look at RE appreciation without comparing that to the appreciation of something else.
- Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes4y
@Joe Villeneuve The one gap I see in your position is that you can use equity to borrow what you would call "real money." I think your response would be it's not real money if it's recourse debt but how would you explain nonrecourse debt? Equity has present value. You can't deny that.
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