Sunny DF

Archive for April, 2009

Many people who purchase real estate have no idea what equity is, what creates it, what destroys it, and what to do with it. People who purchase real estate use the phrase “building equity” to describe the overall increase in equity over time.

Initial Equity is the amount of money a purchaser puts down to acquire the property. Financing Equity is the gain or loss of total equity based on the decrease or increase in loan balance over time. Inflation Equity is the increase in resale value due to the effect of inflation. This kind of appreciation is the “inflation hedge” that provides the primary financial benefit to home ownership.

There are a number of fallacies about residential real estate that either affirm the belief in perpetually rising prices or minimize the fears of a price decline. These fallacies generally revolve around a perceived shortage of housing or a belief that the higher prices are justified by current or future economic conditions.

In every asset bubble people will claim the prices are supported by fundamentals even at the peak of the mania. When rental cashflow models fail, which they do during the rally of a housing bubble, the arguments justifying prices turn to an owner’s ability to make payments. The argument is that everyone is rich, and everyone is making enough money to support current prices. Data proves this argument to be a fantasy.