So, right now you’re probably thinking, “What?!? Are
you crazy!?! Of course I want to get the lowest possible price!”
Hear me out: Home prices are set based on comparable
home sales in a given neighborhood. If the lowest comparable home sold for
$250,000, and the highest sold for $400,000, then the median comparable home
price is $325,000. Now, if you purchase a comparable home in the area for
$205,000, you've just lowered the median price to $302,500, which is a 7%
decrease in the median home value. That means that every other comparable home
that goes on the market is going to be looking at the new, lower median price,
and homes that are currently on the market are going to be encouraged to lower
their prices to be comparable with your new home’s selling price. This can
create a nasty downward spiral in a given neighborhood that can take a long
time to correct (sometimes years).
Now, this doesn't sound like a big deal, until you consider
that eventually you’re probably going to sell your new vacation home. Or, even
if you don’t sell it, maybe you want to take out a home equity loan to do some
improvements. When the appraiser comes to value your home a few years after you
purchased it, he comes back with a value of $225,000. Hey, you didn't lose
money. But then you start to think about all the improvements you've made and
how you know you've put at least $20,000 into the place, and after all, it’s
been five years, it should have gone up by at least the inflation rate (which
would put it at around $249,000 over five years at 3%, not including the cost
of improvements). What happened?
Well, after you bought your house for $205,000, other homes
that were for sale lowered their prices. Pretty soon, the highest comp in the
area was only $360,000, and the lowest was $190,000, making the median price
$275,000. Now, even as homes in the area started to creep back up in value as
the overall market improved, it was slow going.
Now, let’s say that you had paid $250,000 for your home.
It’s on the low-end of comparable properties, but it didn’t throw off the
median price. Property values continued to creep up at just over inflation
(let’s say 4%). When the appraiser comes in to value your home after five
years, your home’s value is now $305,000, even without improvements. That means
that you now have $55,000 extra in equity. Considering that you spent all
the equity you had gained in the previous example on improvements, even given
the higher purchase price, you’re still $10,000 ahead of where you would have
been with the lower price.
And, since you’re a savvy buyer and realized that it was a
buyer’s market, you negotiated $15,000 worth of improvements to the property
that the seller completed before you closed on the home. This means that you
can effectively add another $15,000 value (plus appreciation) to your home. So,
you’re really coming out on top. Give it another five years at the same
appreciation rate and the value is now over $370,000, giving you an additional
$65,000 in equity.
In the first example, even if after five years it
appreciates at 4% per year for the next five, your value is still only going to
be around $273,000, almost $100,000 worse off than if you had paid the
higher price in the first place.
While on the surface getting the best price might sound like
the way to go, in reality, it can harm your financial situation in the long
run. This can be even more true with properties that you’re holding for
investment. Unless you’re in a market that’s experiencing a solid upswing, and
are planning on doing a lot of improvements in a property before reselling, getting
a price significantly lower than comparable ones in your area could well do more
harm than good. Instead, get the seller to throw in other incentives, such as
improvements or prepaid mortgage interest. That way you’re still getting a
great deal without harming the overall market.
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