We know the story. The one that says house prices will just go up. Some say 2008 was a blip at the height of a bubble. But that’s done now. The economy is recovering and prices should recover. And even if we are still not so sure, Quicken Loans appeals to our patriotism and reminds us that America was founded on taking great risks like sailing across the Atlantic, sending a man to the moon, or signing a 30 year mortgage to buy a home.
Whether or not we believe taking on 30 years of debt to secure a home should be as risky as the first space flight, we should at least better understand what causes local house prices to change instead of depending on our “colossal self-belief” as Quicken Loans suggests. To do so, I’ve conducted analysis on year over year house price changes for 14 Chicago submarkets from 2007 to 2013 using data from the city of Chicago, the DePaul Institute for Housing Studies, and IRS tax information and found the following factors predictive of house price changes in a single year. They follow:
- A 1% increase in all cash buyers (who tend to be investors) predicts a 0.52% decrease in prices
- A 1% increase in theft predicts a 0.37% decrease in prices
- A 1% increase in owner improvements predicts a 0.13% increase in prices
- A 1% increase in new construction predicts a 0.07% increase in prices
- A 1% increase in the number of businesses predicts a 0.05% increase in prices
These items were found to be significant across a variety of other attributes, such as changes in foreclosures, changes in violent crimes, changes in renovation permits and changes in household income.
From the results, we understand that investing in a home is more akin to investing in a neighborhood. Factors such as theft and an increased presence of investors hurt neighborhood prices. Owner improvements, new construction and new businesses help house prices. Individual homeowners do not control these factors, but these factors contribute to the value of each individual home.
Additionally, my analysis shows that local markets depend on each other’s prices. A homeowner in Lincoln Park is effected by downtown and Wicker Park prices. A homeowner in Englewood faces the risk of West Garfield Park prices and vica-versa. This dependence is significant, so simply buying in a lucrative neighborhood is not without risks of the surrounding areas. Every neighborhood in Chicago is effected by these factors, and these housing markets are very dynamic and complicated indeed.
Hopefully, we can understand that buying a home is a risky investment. Risk is not bad if it is understood. But because so many homeowners use a 30 year mortgage to purchase a home, it is even riskier. If prices fall, the mortgage debt is still the same, so a homebuyer can end up:
1) Paying more money to live in a neighborhood than it is worth at a given point in time AND
2) Losing money on the home investment while repaying the original debt plus interest in full
Generally, the lender does not care about these risks since the homeowner bears them, even though they are outside of the homeowner’s control. Companies like PartnerOwn however are pioneering new ways of financing home purchases. We have created a Local Market Insurance (LMI) contract that links a borrower’s monthly payment to changes in the local housing market. If the market goes down in value, so does a borrower’s monthly payments. These savings never have to be repaid. And a mortgage borrower will never have to pay more than the original monthly amount.
Thank you for your time!