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Housing Conundrum — When 1 does not equal 1

CHICAGO, IL

By L.S.
A.B. Dada is out of town due to a family member having surgery.
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Someone I worked with years ago is feeling pretty lucky about the house they’re trying to sell. They feel good because they don’t really understand the math involved in the process of what they’re losing. I feel bad for them, but after a few hours total of repeated explanations I gave, they still can’t see that 1 does not always equal 1 when it comes to price changes.

I believe they bought their house for US$400,000 in 2004 — quite shy of the peak value of the property which was supposed to be about US$480,000 in mid-2006. This is a 20% upswing, a gain in value in pure dollars. In terms of real value gained, it is hard to say — how much value had the dollar lost in 1 year in terms of what they bought and their lifestyle?

I know they took out a HELOC (home equity line of credit) in early 2005 and extracted some amount from it — a vacation and some nice household items were added. I’m not sure what amount they extracted, but I’m guessing around US$40,000. I do know they closed on the loan with only 5% down, and there was definitely PMI included in their mortgage cost. Luckily, they had refinanced with a fixed rate loan.

Their house went on the market for US$500,000 a few months ago, but hasn’t budget at all. They told me they don’t mind, they know their house gained 20% in value in just 16 months. If they have to sell for US$450,000, it’s only a 10% loss from what they were asking. 10% versus 20% — sounds like a fairly close number, doesn’t it?

My explanation to them is that a US$100,000 house that appreciated to US$200,000 goes up 100% in dollar-value. If that same US$200,000 house drops to US$100,000, it is a 50% loss in dollar-value. The actual price in dollars moved the same — US$100,000 up, and US$100,000 down. The percentage, though, was 100% up, and 50% down. You can’t compare percentages in upward and downward motion!

Gaining 20% in dollar-value and losing 10% in dollar-value is NOT the same thing. Once you factor in the HELOC extraction (the vacation has zero resale value now, and the home items probably depreciated 50% the day of purchase), the maintenance and tax costs of living in that nice neighborhood, and the realtor fees of 5% or so that they’ll have to pay on closing, the numbers don’t add up. They didn’t get any offers at US$500,000. I don’t believe they had even one interested party at the open houses. The 20 or so people who showed up without realtors were likely neighbors who wanted to see what they had going on in the walls.

What will happen if they have to sell at US$400,000 or US$350,000? That’s a loss, no matter how you look at it. Sure, everyone pays property taxes, some pay home owner’s association fees (they did), and everyone pays the realtor, but the loss is significant, especially if you walk away having to pay the bank beyond the check you get from the buyer. In this case, selling the home for US$350,000 after paying the realtor nets you about $332,500, or a total loss of about $67,500 in that time period — NOT including taxes, maintenance, upgrades, and association fees. Ouch.

We have to stop looking at percentages when it comes to valuation of what we buy and sell. We have to stop comparing dollars in one year to dollars in another — with each family and market having different costs of living and different real inflation figures, it is even harder to know what you made or lost. People who walked away with a 10% profit over 3 years may be lucky to break even, but considering many are selling houses that are decades old, even breaking even is an amazing thing.

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