Will buying a home help you to meet your financial goals?
While not all benefits of home ownership can be measured in dollar amounts, the potential to build wealth and create financial stability is surely high on the list of priorities, if not at the top.
One of the most important factors to consider when evaluating a home purchase is how much a home is expected to appreciate (i.e. increase in value) during the length of your ownership.
Appreciation: The key to a profitable home investment
Appreciation refers to the increase in the value of a property over time. If the market value of a home increases from $500,000 to $515,000 over the course of a year, that amounts to 3% annual appreciation.
If you want to turn a profit when it’s time to sell, having sufficient appreciation is essential. It also builds your equity while you own the home, giving you the flexibility to make financial maneuvers such as doing a cash-out refinance or taking out a home equity loan should you need to utilize those options.
According to the Joint Center for Housing Studies at Harvard University, since the year 2000, the Washington, DC-Metro area has experienced an average annual appreciation of 5% adjusted for inflation.
What factors influence appreciation the most?
Housing prices are dictated by supply and demand. When there are more home buyers than there are available homes, prices rise. If there is a surplus of homes, prices fall. That much is obvious. So what should we look for to understand if demand will be increasing or decreasing?
The four indicators that have the most impact on appreciation in the Washington, DC and Baltimore Metro areas are:
- Strong job market
- Desirable public school systems
- Reputation for safety
- Cleanliness of the environment
If one of these areas is lacking, home buyers will have doubts about the future prosperity of an area and will hesitate to make an investment. This leads to home values stagnating or dropping.
Some other factors that are also important, but have a bit smaller impact on appreciation are:
- Public sentiment regarding the economy
- Mortgage interest rates
- Local property tax rates
- Energy and water costs
- Insurance costs
- Access to quality food
- Accessibility and quality of public transportation
- Access to Medical care
- Shopping, dining, and entertainment options
- Proximity to international airports
- Public parks, green space, and recreation options
Have you researched these items for homes you are interested in? An important part of doing your due diligence before buying a property is looking for positive trends and upcoming changes that can add value to an area.
How much home appreciation do you need to meet your financial goals?
Let's run through a hypothetical scenario. Say you are planning to purchase a townhome for $450,000, with the intention of living in the home for 7 years before selling and moving up to a larger home. You'd like to make a net profit of $100,000 from the proceeds of the sale to put towards the down payment on your next home.
You made a 20% down payment and have a 30-year fixed-rate mortgage with an interest rate of 6%.
If we don't account for the amount of mortgage interest paid over those 7 years, transaction costs, and the cost of home repairs and maintenance, we would arrive at a sale price target of $550,000 in order to make a $100,000 profit in 7 years. That would require a rate of appreciation of 2.9% per year.
However, If we factor in the $144,018 of mortgage interest paid over those 7 years, and estimate 3% of sale price in closing costs when purchasing and 7.5% of sale price in closing costs and home repairs when selling, you'll need to sell for $764,884 in order to have a net profit of $100,000 before taxes. That would require an annual appreciation rate of 7.87 %. A “break even” sales amount at 7 years would be $653,245 which would require 5.47% annual appreciation, not accounting for the time value of money.
With an average of 5% annual appreciation in the DC metro area since the year 2000, you would need to find a property in an area that you expect to experience appreciation well above average. Otherwise, you’ll need to extend your timeline or find a lower interest rate. If the mortgage interest rate was 4%, an appreciation rate of 6.75% would be required to achieve your net profit target.
Regardless of what your goals are, be sure to run your numbers before making a long-term investment in a home.
Be an informed home buyer
Understanding the factors that drive home value appreciation is crucial for making a financially sound home investment. It’s important to do your research and to set realistic expectations for appreciation, but also to acknowledge that unforeseen events (e.g. natural disaster, pandemic, etc.) may result in a completely different outcome.
Do you want help running your numbers or identifying the best areas to purchase in the Washington-Baltimore metro area? Schedule a no-commitment consultation with me and we’ll discuss your goals and create a plan for your success!