Why Home Appreciation Values Aren't All They're Cracked Up to Be

With real estate prices tanking and bargain basement deals seemingly popping up in just about every form of real estate there is, I'm still not a fan of real estate as an investment vehicle (with the possible exception of vacant land), and I'll tell you why. Even with the drop in home prices after the real estate bubble burst, I read somewhere just the other day that real estate has appreciated somewhere to the tune of around 50% since the year 2000 until the end of the decade, which is a heck of a lot better than the stock market has done.

So back to that 50% appreciation -- recognizing that this number is a national average and won't be applicable to places like Detroit where prices have plummeted much further than most other major cities. 50% sounds like a pretty decent return over a ten-year period, right? I would tend to agree if that number was all it appeared to be, but in my opinion, and based upon personal experience with homeownership, it fails to take into account several major drains upon your return. It's like saying you've made 10% this year on your stock portfolio before you factor in broker commission, fees, taxes, etc. or that you've made $60,000 this year in income but don't factor in income taxes, health insurance costs, and all the other payroll deductions.

When I started deducting items like mortgage interest, property taxes, repairs and maintenance, homeowner's insurance and the likes from that 5% average annual home price appreciation, I was surprised at what I found.

Mortgage Interest

Let's start with mortgage interest and the effects it has upon your potential home appreciation using as an example a $200,000 home with a corresponding 6% interest, 30-year fixed rate mortgage. To make this example a bit easier, I'm not going to amortize principal and interest payments with each year of the loan, simply taking a base average of interest payments over the 30-year period instead.

Assuming you make no extra payments throughout the course of the loan, you'll be paying an average of about $7722.55 a year in interest. Of course this interest amount would be higher initially and lower toward the end of the loan according to an amortization schedule, but for ease of this example, we'll just stick to the yearly average over time.

Based upon that average, about 3.86% of the value of the $200,000 would go to pay mortgage interest.

Property Taxes

Ah, property taxes, the bane of the homeowner's existence -- they're there every year, never go away, and rarely decrease (at least until you hit your senior exemption status if you're lucky enough to do so).

According to Forbes.com , the national average for yearly property taxes is $1180. This means that in our example another .59% of the $200,000 home's value goes to paying property taxes.

Repairs and Maintenance

The repairs and maintenance needed to maintain a home will, like property taxes, likely never end. There will be years where you might skate by only have to change the occasional light bulb or paint the porch railings, and there will be other years where you may undertake replacing the roof, putting in a new driveway or other major repairs.

According to homemaintenanceinfo.com , the average annual home maintenance cost ranges somewhere near 2% of a home's price. Of course, depending upon the age and location of a home, this number could vary significantly. For our example though, 2% would mean about $4000 a year in repair and maintenance costs, increasing annually with the home's "appreciation" and age.

Homeowner's Insurance

Then there is homeowner's insurance -- something you'll hopefully never have to use, but is nice to have if for nothing else but piece of mind. Homeinsurance.com places the national average for the cost of homeowner's insurance at $669 a year. Again, this number can range significantly depending upon the size, location, age, and use of a home as well as numerous other factors. For our example, $669 would be .33% of our home's $200,000 value.

Total

So let's take a look at our total annual average of what may be considered fixed home expenses in relation to the $200,000 home's value.

Mortgage Interest - 3.86%

Property Taxes -- .59%

Repairs and Maintenance - 2%

Homeowner's Insurance -- .33%

TOTAL - 6.78% of home's value

Payoff Difference and Other Factors

You might be thinking to yourself that if each year a home increases in value by a certain percentage, the compounding factor would help its value eventually overcome expense amounts. For example:

Year 1 @ 5% appreciation = $210,000

Year 2 @ 5% appreciation = $220,500

Year 3 @ 5% appreciation = $231,525

And so on...

It is true that appreciation will become increasingly more valuable dollar wise each year as long as the home continues to appreciate. But, you must bear in mind that costs in just about every other categories (taxes, repairs and maintenance, insurance, etc.) will likely be steadily increasing as well (i.e. the more valuable your home the higher property tax rate, the more it costs to insure, repair, etc.).

You might also be wondering about when the home is eventually paid off completely. Won't that be better for the value? Sure, it can certainly help, but even taking mortgage interest off the table, you're still probably looking at least 3% of the value of the home just to sustain the necessary costs, if not more so. That leaves you with 2% appreciation per year at best if you're able to ride out real estate fluctuations for the long term. You could probably do better with a good certificate of deposit or savings bond, and those save you the time, trouble and aggravation of sustaining a home. Plus, don't forget to factor in the costs if you want to eventually sell your home using a realtor, which could have you writing off another 5-7% of the overall sales price.

In Summary

After all is said and done with my above example, I recognize that a home is a home, and you have to have somewhere to live, especially when it comes to larger families. And while I'm not a fan of homeownership, preferring cheap rent, $100 a year in renter's insurance, no property taxes, and someone their to fix any maintenance issues when they occur, this article is intended more to make you think about just how profitable a home actually is when the pundits start throwing around these home appreciation percentages.

However; a large part of just how profitable a home actually is can depend on many factors, including your location, family size, as well as those issues discussed in this article. I live in a place where property taxes are often at least four times the national average or more, so you can imagine that owning a home here is much more costly than in other areas of the nation, making it difficult to get your money's worth out of home value appreciation. These are the types of things you should consider before ever buying a house -- or letting your wife and her family talk you into buying one as I did!

More from this contributor:
My Mortgage Mistake
Home Investment: One Man's Battle Against the Odds
How to Manage a Household Budget

Disclaimer: The writer is not a licensed realtor, financial advisor or financial professional. The information provided in this article is for informational purposes only and does not constitute legal, financial or real estate advice. Any action taken by the reader due to the information provided in this article is solely at the reader's discretion. All calculations were performed to the best of the author's knowledge and have not been verified.