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Real Estate Appreciation – It Can’t Beat Income Growth

by on August 20, 2012

A Guest Post from Paul Gabrail –

I have family/friends in many “hot spots” for real estate in this country: California, Florida, Arizona, Massachusetts, etc…They think that prices will go back to a stable growth rate.  When I inquire about what they think a normal stable growth rate would be, I have heard 6-7% and I am floored.  Granted, not everyone says that.  Most of them say “I don’t know” and they just leave it at that, which is probably a better answer than 6-7%.

I know that many in this country are used to the 2000s where rates of growth were in the double digits in many markets across the country. Most would think that 6-7% would be very reasonable compared to double digit growth rates, which is something I can understand.  But just like the stock market and other investments, just comparing to boom times and bubbles is going to cost someone in the long run.

Do you want to know how much real estate in your area will go up?  Well, there are two major factors: Supply and Demand. Just like everything in life, supply and demand is key. I have a previous post titled Real Estate – Supply vs Demand…which is more important? in which I discuss the supply side in great detail, but from the demand side, there is one major factor that matters: Income growth.  For the long run (20+ years), and keeping supply issues (population growth and land availability) constant, real estate values cannot grow at a pace that exceeds the income growth in that particular area.  Does it sound complicated?  I hope not. But if it does, here is the logic behind it…

Let’s say that someone who makes $50,000 per year can afford to buy a $100,000 house.  Nothing crazy.  So let’s say in 20 years, their income has gone up 5% per year and they are now making $132,000 per year.  It is logical for someone to say that since their purchasing power has increased by 165%, they should be willing to pay 165% more for that $100,000 house.  That is not an unreasonable hope/expectation.  So their $100,000 house has gone up to $265,000 in value and that makes sense.  Now, just extrapolate that out as 1,000,000 people in an area who have an average income of $50,000. They should all be willing to buy 1,000,000 houses worth $100,000 each.  The percentages are the exact same, but the amount of dollars is much higher, but it’s all the same math.

So now let’s look at what my friends/family are saying and let’s look at some historical data from certain areas.  They believe that in these major markets they should be able to see 6-7% appreciate per year over the long run.  Let’s pick one spot: California.  Very nice climate.  People are moving there.  Business is moving there, so it’s a happening state. The supply side of the equation is definitely HELPING real estate values.  Back in 1970, the population of California was 19,950,000 and now it’s over 37,000,000! That is a large increase for such a large state as it is.  So clearly there was increasing demand in real estate as their population went up almost 90% in 40 years! Compare that to my home state of Ohio which has only gone from 10,600,000 people to 11,500,000 people in 40 years.  A mere gain of 8.5%!

Since 1970, the average home in California has gone from $25,000 per house to $160,000 per house which is an annualized increase of 4.4%.  Still VERY respectable and a nice appreciation rate. Yes, they have seen the brunt of the drop in the last few years, but they also saw the large increase in the late 1990s as techs were booming and in the early to late 2000s as interest rates were low and real estate values were skyrocketing.  Meanwhile, the average per capita GDP in California was $4810 per person to $53,000 per person, which is an annualized increase of 5.75%!

So, as I said above, real estate values will most likely  NOT grow at a pace faster than the increase in income, so even with a state like California who has doubled its population in 40 years and has seen growth each year and has experienced the highs and lows of real estate…they still haven’t seen massive price appreciation above regular income.

Now compare it to Ohio. Like I said…barely any increase in the population.  Let’s compare income to real estate values.  In 1970, the average house in Ohio was selling for $17,600 and today, the average home is selling for $151,320, which is an annualized increase of 5.57%! So in a time where Ohio only gained 8.5% appreciation while California almost doubled, we outpaced them in appreciation as a state.  Let’s look at income: In 1970, the average Ohioan made $4086 per year and now they make $42,083, which is an annualized increase of 5.57%!  Again, in a very consistent population growth state, we didn’t even see real estate values beat the growth of income.

If all this data was a lot to grasp, look at the chart below to see the recap:

California

Avg Home Price

AvgIncome

1970

$25,000

$4,810

2012

$160,000

$53,000

Ann. % Change

4.4%

5.75%

 

 

 

Ohio

Avg Home Price

AvgIncome

1970

$17,600

$4,086

2012

$151,230

$42,083

Ann % Change

5.10%

5.57%

As you can see above, income grew at a rate 30% higher than real estate values per year in California over the 42 year period and 9.2% higher in Ohio per year over the same period.

So going back to our example above of the person making $50,000 per year and buying a $100,000 house, if their income increases by 5% per year, in 20 years, they will have the $132,000 in income, but if the real estate values go up by 7% per year, a mere 2 % difference, instead of having a house at $265,000 to purchase, their house is now $386,000! Quite the difference and on income of $132,000, that may be a bit harder.  Go 20 more years, and the 5% increase in income goes to $350,000, but now their house at 7% is now having to be purchased for $1.497Million! Clearly, the same house with the same wage earners cannot grow that much higher than income levels over the long haul.  It has to be like the situation above where income outpaces real estate values and, at worst, they grow at the same rate.

Year 5% Income Appreciation 5% Real Estate Appreciation 7% Real Estate Appreciation
0 $50,000 $100,000 $100,000
1 $52,500 $105,000 $107,000
5 $63,814 $127,628 $140,255
10 $81,445 $162,889 $196,715
15 $103,946 $207,893 $275,903
20 $132,665 $265,330 $386,968
30 $216,097 $432,194 $761,226
40 $351,999 $703,999 $1,497,446

As you can see from this chart, the same house went from 2X the income of the individual to almost 5 times the income! Any mortgage banker will tell you that a house cannot be bought for $1.5MM on income of $350,000 per year! Granted, it took 40 years, but even after year 20, it was almost triple the income.  It’s just a matter of time before things have to settle back to normal.

Unfortunately, as our economy matures more and more, I don’t think the rate of income over the last 40 years will be the same for the following 40 years.  Our economy is too mature and strong to have the large growth rates that we had experienced in the past. if the last 40 years didn’t beat 6-7%, why would we expect the next 40 years to do the same?

About the Author: Paul Gabrail is a partner at Select Investment Group, a real estate investment firm, and a blogger at thecapitalistmanifesto.com. For more articles and thoughts like this, follow Paul on Twitter @capmanifesto, subscribe to his RSS feed or visit his blog thecapitalistmanifesto.com.

 

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A Mitt Romney Ice Cream Roundup

by on August 19, 2012

We’ll start this week with 10 Conveniences You Can Probably Do Without, at Faithful With a Few. Most financial bloggers will agree that there’s a limit to cutting expenses, and that increasing earnings should be a priority. No argument there, but new jobs, promotions, or side gigs usually take a bit of time to kick in. Meanwhile, the cost cutting can help get your budget in line, now, and this is a great list to get you going.

romneyicecream

Today’s title? I wrote about how I was a few feet away from Romney in 5 Years Returns, Sir. It was a strange coincidence to find myself staring across the room at Romney, too bad he didn’t answer.

At Money Reasons – Is A Roth IRA One Of The Best Protection Against High Future Tax Rates? Tough decision, Traditional IRA vs Roth, mostly because we can’t know what out rate will be at retirement. In fact we never can be certain what our rate will be next year. So check out the article and my (hopefully) insightful comment there.

At Oblivious Investor, an answer to the question How Do RMDs Work with Multiple IRAs? As with the prior article, most issues surrounding IRAs are neither obvious or intuitive, and this is one question that might help you in the future.

Wrapping up the week, Miranda’s What Do You Like Better? Coins or Bills? Or Plastic? Like or not, the direction is definitely toward plastic, and likely not even plastic. I can see a time when a thumb print or retina scan will be all you need to transfer fund, along with a secure PIN of course. The plastic is just a first step.

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Romney’s Mission

by on August 18, 2012

It’s looking more and more like Romney’s mission is to save the rich. This is how any of his tax proposals seem to read.

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5 Years Returns, Sir!

by on August 16, 2012

This post appeared in my short-lived site Romneyomics.org. It existed because I was interested in an ongoing dialog of how Romney’s policies would affect the economy, combined with my belief that this man had nothing in common with the average American. An ongoing series of Romney posts at this site would have grown tedious, and too political. That said, when Obama won a second term, the site’s existence became moot. This was one article I had published which linked from JoeTaxpayer.com, and I’ve moved it here to avoid a bad link.

As both of my readers (sorry, are there 4 yet?) know, the democrats have requested that Romney produce 5 years worth of returns, nothing new there. But. yesterday, I’m watching CNN, and our President is telling the crowd during a speech, if you see Mitt Romney later, ask him why he won’t show five years worth of returns.

romneyicecream

In a “yes, my life is strange” moment, a couple hours later, I’m in a restaurant on Nantucket. A friend tells me Mitt Romney is now on the island. Ok. Small island but a hundred restaurants. As we’re finishing our meal, the eagle has landed. The kid hands me her phone to snap a photo of my thumb and Romney. Right after the shot, I call out “five years returns, sir.” Secret service tells me to quiet down, so I wait till he’s out the door, still ignoring me and I repeat my line to mild applause from within the restaurant. I go back to my table and ask my wife and daughter what the odds are. They both respond “One in three.” It’s a family joke, as I’ve had some remarkable coincidences happen over the years.

This issue may be the one thing that wont go away. If, in fact, his average tax rate turns out to be 13%, just produce the returns. A capital gain rate of 15% and some large donations (good for him, no criticism regarding lowering your taxes this way) and his rate may have been 13%. But unless and until he shows his returns, it will be like when a certain moron real estate developer kept going on camera asking POTUS to produce his birth certificate. For a $25 donation I got a “Made in US” mug showing a miniature copy of that certificate.

I know you heard me, Mr Romney, and I know you’ll hear it from others, show the returns, Five Years Returns!

Update – The above occurred Saturday night; on Sunday morning my wife Googled [Romney Millies Nantucket] to find a brief newswire story about the visit. AP referenced this with “Several Millie’s patrons wished Romney well. But one man shouted “five years’ returns.” He was alluding to Democrats’ demands that Romney release five years of his tax returns instead of two.” Pretty cool, but I did call him “Sir” as indicated in the post title.

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Money-Management Tips for College Students

by on August 13, 2012

A guest post from Patricia Shuler –

Take a bite out of your student debt load with these simple tips

Your college years are a tight squeeze, financially—your expenses have never been higher, and your earning power isn’t much more than it was when you were flipping burgers in high school. For most students, that means debt, and lots of it. These money management tips can save you thousands of dollars over the course of your university experience—dollars you won’t be paying interest on when you’re 35. I’ll only mention money-saving moves that will save you over $1,000. There are other ways to cut costs, but these are the big ones.

1. Submit a FAFSA
This is a huge one; a Federal Application for Student Aid (FAFSA) provides access to Pell Grants and subsidized student loans that can make college affordable for almost anyone. If your parents aren’t paying for your college tuition, make sure to mark that on your FAFSA, and you will almost certainly qualify for a grant (unless for some reason you’re already earning middle-class wages after school).
If you’re working a low-paying, part-time job, you can generally qualify for $5,500 a year in Pell Grants, along with $10,000 in yearly subsidized, low-interest student loans—loans that don’t even start accruing interest until you graduate. Over the course of a four-year degree, that adds up to $22,000 in no-strings grant money, along with $40,000 in subsidized loans if you need them.

2. Pick a starter school
If you plan on attending an expensive school, there’s very little reason to complete your general education requirements there. Instead, pick a smaller, two-year school that will provide an “Associate of General Studies” or similar degree for a fraction of the cost, and then transfer to your dream school. Four-year universities generally waive the general-education requirements for students transferring with a two-year degree, so take advantage of the savings. Once you’ve brought home that degree from Stanford or Georgetown, no employer is ever going to ask if you were a transfer student.
Depending on how pricey your school of choice is, this option can save you tens of thousands of dollars over two years, and if your high school grades were less than stellar, it gives you an opportunity to boost your GPA and qualify for better financial aid.

3. Don’t pay full tuition for your internships
In order to work without pay legally, you have to be enrolled at school so the company you intern for can justify the internship as “training”. But the good news is, most companies don’t care what school you’re enrolled at during the internship, and most community colleges will let you enroll in a dirt-cheap summer “class” to cover your internship period, so you don’t have to pay summer tuition at your prestigious, expensive university. Even more so than finding a starter school, this tip is almost always a good idea.

4. Ditch textbooks, buy a tablet
The average student spends $1,200 on textbooks every year—many of which are unhelpful, and almost none of which will be resold at a fair price. Meanwhile, e-book versions of textbooks are routinely priced at one-half to one-third the cost of hard-copy editions, especially if you go with “rental” versions whose rights expire. Over the course of four years, buying e-book editions at half price will save the average student $2,400. Tablets won’t replace laptops, at least not for a couple years, but the extra money you’ll put down for a tablet will be made up in textbook savings within the first year.

Patricia Shuler is a BBGeeks.com staff writer from Oakland, California. She’s an admitted tech-junkie who’s quick to share her honest opinion on all things consumer electronic—including up-to-date news, user reviews, and “no holds barred” opinions on a variety of social media, tech, computer, and mobile accessories topics.

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