I’ve been analyzing real estate, I’ve come up with a simple rule that helps me understand how a given property’s value might change over time. I use it when I analyze office buildings, shopping centres, industrial warehouses, apartment buildings, self-storage properties, houses, and generally any real estate investment a person or company can make. Here goes.
The Golden Rule of Real Estate (Part 1 of 2)
Buildings never go up in value. Ever. Period.
Pretty simple, no?
That statement is true of all types of buildings, including houses. If you can accept that as a universal truth, you’re a lot closer to understanding property value than most people ever get.
But Alex, have Canadian house prices risen at an average of almost 5 percent a year for the last twenty-five years?
Yes, they did. But we didn’t talk about why.
The trick here is that you generally don’t just buy a house — you buy the house and the land that it sits on. The actual house goes down in value in real terms. Always. Without any exceptions.
That’s because, as a house gets older, it wears out. The roof gets older and maybe it starts to leak. The furnace gets older and needs repairs. The kitchen starts to look older, a little bit worn, and maybe the colours go out of style. The counters wear out. The fridge dies. Even the floors eventually weaken and begin to fail. Detached home, townhouse, high-rise — parts of every home wear out over time.
Virtually every element of a house gradually fails. That is why there are maintenance costs. If we do a great job of maintaining a house, by keeping on top of regular maintenance items and servicing all the various elements of a house, we can slow down the pace at which the house goes down in value. But there is a cost to maintaining a house, and those costs don’t increase the value of a house, they maintain it.
If buildings go down in value, how have home prices risen?
The Golden Rule of Real Estate (Part 2 of 2)
Only land can go up in value.
Some land goes up a little, and some goes up a lot. Sometimes the land goes down in value. But the house always goes down in value. Both parts of this rule are important to keep in mind when considering “investing” in a home and when comparing the potential financial benefits of doing so compared to the cost of renting.
This rule I’ve created helps me to gain perspective when I’m trying to value real estate. I created the rule based on a few things I kept noticing as I was making my way into the real estate industry:
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