Note: for Part One of this article, click here >
Despite the national scope of the housing downturn, our look into the latest equity picture reminds us that real estate is incredibly local. For instance, 55 metropolitan areas have had positive price appreciation over the five year period ending in 2010. Among the 99 areas that have had negative price appreciation, even if a buyer had put nothing down but taken out a regular 30-year fixed-rate mortgage and paid it regularly upon purchasing a median priced home, equity would remain in 33 areas¹. A resumption of normal² price growth (without accounting for further mortgage principal payments) would restore some equity in 20 areas in about a year and an additional 29 areas in about 2 years.
However, one reminder of the severity of the recent housing crisis is the fact that among the 66 metro areas where an owner would be currently underwater, the owner would be more than $100,000 underwater in the worst 10 areas. These 10 areas are all in the “boom and bust” states of California, Nevada, and Florida as seen in Table 1.
Over the last 10 years, the price and equity picture is much brighter. Median buyers in the top 30 metro areas could have accumulated $100,000 or more in equity. Interestingly, 4 of the 6 California cities that have had the biggest equity losses over the last 5 years are among the biggest gainers over a 10-year horizon as shown in Table 2.
Only 12 of 154 metro areas had negative price growth over this 10 year period, and only 5 areas—concentrated in the “rustbelt” states of Ohio and Michigan—saw a decline substantial enough to leave a median buyer underwater. These results are shown in Table 3.
While hindsight enables us to pick out areas of long-term decline, those where a loss of employment base and population has translated into lower home prices, studies suggest that this type of decline is difficult to predict and suggest that the uncertainty surrounding potential outcomes for neighborhoods and cities that face short-term setbacks may paralyze lending and other activities that could otherwise serve to reverse the trend of decline³.
Over an even longer term, we see positive equity build-up in all areas. For example, in 73 of the 154 areas in this experiment a buyer who bought at the median price 20 years ago could have over $100,000 in equity in her home. In an additional 70 areas, the buyer could have more than $50,000 in equity. Take a look at overall performance in your metro area by downloading one of our local presentations here.
Of course financial considerations are not the only factors that matter to owners. There are substantial nonfinancial benefits to buying a home—owners have a stable place to live and the bulk of their monthly housing costs, principal and interest, will not go up. There are also further social benefits—homeowners are more likely to invest in their community by participation in membership and community organizations. Realtors help buyers and sellers by navigating the local market and also by increasing awareness of these long-term financial and nonfinancial benefits to home ownership.
Of course, these calculations required a few assumptions, so here’s the full disclosure.
- I assume that homeowners had 100 percent financing for the purchase price of the home (i.e. did not make any down payment). This would tend to underestimate the amount of equity earlier home purchasers have accumulated. In 2003 39 percent of first-time home buyers put 10 percent or more money down upfront according to the National Association of Realtors® Home Buyer and Seller Survey. While down payments trended down throughout the decade, for example, in 2005 and 2007, 43 and 45 percent of first-time home buyers, respectively, financed 100 percent of the home purchase price. More recently, downpayments have trended up. While 34 percent still financed 100 percent in 2008, the 2009 data show that only 20 percent of first-time home buyers financed 100 percent of the purchase, and the figure for 2010 was 17 percent.
- I also assume that homeowners have not tapped into any of the equity in a home with lines of credit. This is likely to overstate the amount of equity currently available to home owners, but does not affect the consideration of how much equity could have been built up.
- I assume that home buyers financed with a 30-year fixed rate mortgage, that the loan was fully amortized (buyers pay both principle and interest over the 30-year period), and that home buyers have not refinanced since the initial purchase. If buyers took out interest-only or balloon loans, the calculations overestimate equity in a home. The last assumption may lead to an underestimation of home owner equity if buyers took advantage of the opportunity to refinance and did not pull cash out at that time.
- Finally, all equity gains are expressed in nominal dollars.
- Equity from mortgage payments at the prevailing mortgage rate over 5 years would total 7.3 percent of the home’s value. This means, cumulative price declines in the 5-year period have been less than 7.3 percent of the home’s original purchase price and have not completely eroded equity accumulated from mortgage payments.
- Normal price growth is assumed to be 4 percent per year since home prices typically grow at 1 to 2 percent per year above inflation.
- Follain, James R., “A Study of Real Estate Markets in Declining Cities.” Research Institute for Housing America, January 2011. www.housingamerica.org/RIHA/RIHA/Publications/75154_10296_Research_RIHA_ShrinkingCities_Report.pdf