Buyer A and Buyer B buy House A and House B. We’re assuming the houses are the same in every aspect, and the “value” is $300,000 and that House C is the same too. Each house needs a $10,000 roof. All the seller cares about is the net in their pocket when the transaction closes. There are no transaction costs involved.
Buyer A offers $290,000 as is and the buyer replaces the roof the day after closing.
Buyer B offers $305,000 with the seller to put on a new roof and pay $5000 in closing costs.
The houses have the exact same “value” the day after closing but a recorded sales price difference of 5% even though the net to the seller was the same. A year later the “value” of the houses is $325,000. House A went up 11% in “value” and House B went up 6.2%.
Does volume average this out or do we put too much stock in using a gross sales price as a market indicator?
I think you need to talk in terms of depreciation to be more realistic, ie, substitute $325,000 with $275,000.
http://news.yahoo.com/s/ap/20080226/
ap_on_bi_ge/economy_rdp
No good news today on the economic front. Consumer confidence plunged, the wholesale inflation rate soared, the number of homes being foreclosed jumped, home prices fell sharply and a report predicts big increases in health care costs.
But, of course, if the house is painted in JP’s favorite color and even if the kitchen is so 70’s he will still give you 60K over comps and refi every couple of years.hehehe
On a more serious note, as the volume of home sales fall the stats will be more susceptible to issues like the one you present.
The two houses do not have the same “value.” Buyer A has to do work to get a functional house; Buyer B does not.
Each buyer may have perfectly good reasons for their choice. Buyer A may not value his time as much as Buyer B. Buyer B may value $5k in the hand more than the 30 years of interest he’ll have to pay on it.
This is why I think the concept of “value” has little use. Just talk about price and keep it simple.
What’s the price basis?
Charles-
I am not sure what is happening to “House C?” Why did you include it?
Also, if “There are no transaction costs involved,” then why is there $5k in “closing costs?” Where are these costs with “House A?”
Ignoring these issues, this is a problem in GAAP accounting too. The purchase of a capital asset is often so complex that it is nearly impossible to determine if it was ‘properly’ recorded. Some accountants/managers are much more aggressive about capitalization than others. While GAAP is not affected by IRS guidelines, which are far more rigid, small businesses often can expense items that must be capitalized by larger operations.
In the housing case at hand, it is clear that a roof is a capital expense, and since a contractor was used, the $10k is nice and clean. What happens when a homeowner does the work himself? Specifically, what about an air compressor and nailing tool? The opportunity cost of the labor? Now we are closer to the problems in GAAP accounting: What’s included?
This is similar to the question: How does book value relate to market value? In this housing case, the “book value” is the recorded at the county value, which remains fixed.
In any event, this is the first time we have discussed how the cost basis is determined.
Now to your question: “Does volume average this out or do we put too much stock in using a gross sales price as a market indicator?”
Here is what would be a perfect case: If the nature of the sales remain the same, then all is good. For example, if we have 10 House As and 5 House Bs sell last year, and this year we have a different group, but not statistically different, of 10 House As and 5 House Bs, we are in the ideal case.
If volume changes, up or down, then as long as ratios are maintained we are in good shape. For example, 20 House As and 10 Houses Bs, or for example 6 House As and 3 House Bs.
NOTE: I assume a random sample that is sufficiently large to produce results within our level of error tolerance… The small sample used in the last example probably would have too much error to be of much use.
Finally, we can normalize the homes and look at variances. For example, since the homes are the same in every aspect except selling price, then the cost per square foot will vary.
Note how the above is a supply side discussion. We could also discuss the demand side: Just assume that different buyers place different values on the “same” homes, even if they are identical. For example, I have been to many auctions where seemingly identical cars have been auctioned, yet the prices vary quite a bit. Why is this?
You have to use “value” to ground the discussion somewhere. Substitute “price” for “value” throughout and you can have the same discussion.
House C was there for a thought I never finished: what is the price/value of house C on the open market? My goal of the post was to point that the recorded sale price may not reflect what was included or excluded from the sale and that can skew the numbers.
bearlee-
“I think you need to talk in terms of depreciation to be more realistic, ie, substitute $325,000 with $275,000.”
The underlying is still the same: If the value of both went to $275k, then it appears that the one that was recorded for $305k went down by a greater gross amount, but the percentage reduction will be different. In fact, take note of the critical are of (290k, 305k) were the $305k looks like a loss, but the $290k looks like a gain.
In any event, cost basis is the bigger issue here. Also the cost basis is historic (i.e. sunk), and does that have any impact on the future?
Charles-
As long as the market is being skewed the same over time given your choice of metric space, then market statistics may indicate the general direction of the market. Different metric spaces will be affected differently–what’s the best metric space is a question that you posed a few days ago.
That being said, we both know that statistics do not predict the future, nor do statistics prove the circumstances of a specific situation.
>>You have to use “value” to ground the discussion somewhere. Substitute “price” for “value” throughout and you can have the same discussion.<< I’m not sure what you mean here. If you substitute “price” for “value”, then the discussion is much simpler. The price of the house with a broken roof is $290k. The price for the house with a working roof is $300k ($305k - $5k kickback). It’s extremely simple. The original statement is confusing only because you insisted that these two different houses have the same “value.” When you do not insist on this, there is nothing confusing about this scenario. This is why the introduction of “value” contributes nothing except confusion.
Leo-
I simply assumed that House A and House B were the same place under two different sales structures (i.e. same seller, same buyer, and so on.). Another assumption might be that the products are homogeneous, and there are many buyers so that no buyer or seller has a major impact on the market. The idea is that at the individual sale there can be manipulation in recorded price at the county level, depending on how the contract is constructed.
Shocking discovery!!!
As I say, a good tax accountant can suggest ways that transactions can be structured so a person from the outside cannot tell the difference, but big tax savings can be realized. For example, an outsider cannot tell if there is a properly executed 1031 exchange, but if it exists, then there is some delay of taxes paid. Also a buyer may want to increase or decrease the recorded value for some reason, maybe to disguise the boot from a 1031 exchange.