“Back When I was a kid…"

This is something that you may have heard quite a bit growing up. Heck, you may have used this line yourself 😉 When we typically hear this line it is followed immediately by something like, “I walked barefoot to school, in the snow...uphill....both ways.”  

Apart from those always interesting moments of reminiscing, I often hear this same sentiment spoken about with regards to the price of real estate and goods. In particular, I hear people say, "Homes [or fill in the commodity] were so much cheaper when I was growing up than they are now." Which prompts me to ask, "Where things really cheaper back then?"  

I know that prices of real estate today are higher in most of the country than they were 10, 15, 20+ years ago. This applies to real estate and almost all goods and services. However, while prices might be higher, that does not necessarily mean that real estate was "cheaper" back then compared to today. The change in price is not a true measure for what is the true "cost" of the property.  When I say "cost," I mean people's ability to actually buy the item at the time.  

There are many factors that influence the true "cost" of goods, like salary, unemployment rate, availability of credit, etc. However, the factor that we will examine here is inflation. Inflation is simply the buying power of money weakening while the price of goods are rising.  

Because of inflation (not to mention, our friend time value of money), it makes it impossible to compare the cost of property from two time frames by simply comparing the price. Rather, to compare property prices from different time frames, we are going to evaluate prices relative to historical rates of inflation to see how the price of property moved relative to the buying power of the dollar. While this is not the only metric to measure whether properties were "cheap" or "expensive," it is a good place to start. 

Let’s see how his plays out. I recently found a 3 bedroom, 2 bathroom home in Los Angeles that just sold for approximately $430,000. Back in 1993, this same home sold for approximately $130,000. At first glance, that seems like a huge price increase that definitely supports the “when i was a kid” argument.  The question is, was the price in 1993 that much cheaper relative to today? I mean, did the price of the home increase faster than inflation/the buying power of the dollar? Let’s find out.

To determine this, we have to see how much $130,000 in 1993 would be equivalent to in today's dollars. In this example, we will assume an average historical rate of inflation of 3.2% (this is a common historical average that I see for this time period, but if you have a different number, feel free to use that). To determine the value of $130,000 in today's dollars, we need our trusted financial calculator. If you don’t have a financial calculator, no problem, simply follow along and everything will be explained.

Answer: (input the following into your HP10bii Financial Calculator)

N (number of months) = 288 (24 years x 12 months/year)

I/YR (interest rate/year) = 3.2 (we are assuming an average rate of inflation during those 24 years of 3.2%)

PV (present value) = (130,000) (this is the value of the home in 1993, notice you must enter this as a negative into the calculator.)

PMT (monthly payments) = 0 (there are no monthly payments here)

FV (future value) = ???? (this is what the value should be today if it appreciated at 3.2%)

After entering this information above, the answer comes out to be $279,922.36. Meaning, that if the property above simply followed the average rate of inflation of 3.2%, today it should sell for approximately $280,000 today, not $430,000. So, this property beat the rate of inflation, resulting in an increased value of $150,000 more than it would be if it followed the "normal" path. For this property, the "when I was a kid" line actually works.

Now, the question becomes, how much did that property actually appreciate? In other words, by how much did it beat inflation? To figure this out, we will go back to our financial calculator.

Answer: (input the following information into your HP10bii Financial Calculator)

N (number of months) = 288 (24 years x 12 months)

I/YR (interest rate) = ??? (this is what we are solving. We are working to determine at what interest rate the property appreciated)

PV (present value) = (130,000) (this is the price at which the property sold 24 years ago, once again, when you enter this into your calculator it is a negative)

PMT (monthly payments) = 0 (there are no monthly payments)

FV (future value) = 430,000 (this is the value that the property sold for present day.)

After entering the information above, the answer comes out to 4.99%. This means that the rate of appreciation for this property was actually 4.99% over the last 24 years, or 1.8% more than the historical rate of inflation.    

One interesting part of this analysis is the huge difference that a small change in interest can have. There is only a difference of 1.8% between the two situations. However, that small change in interest resulted in a price difference of over $150,000 between the two options. Definitely food for thought on your next negotiation....

OK, now I understand that not every part of the country appreciates like Los Angeles.  Some areas are better for appreciation, while others are better for cash flow. So, we will examine another home in another area to see whether the "when I was a kid" line works there when looking at prices. The second home that we will examine is near where I grew up, just outside of Atlantic City, NJ.

This home is a 3 bedroom, 2 bathroom home that sold in 1993 for approximately $115,000.  It recently sold for approximately $210,000. Let's see if this property followed the historical rate of inflation.

Answer: (input the following into your HP10bii Financial Calculator)

N (number of months) = 288 (24 years x 12 months/year)

I/YR (interest rate/year) = 3.2 (we are assuming an average rate of inflation during those 24 years of 3.2%)

PV (present value) = (115,000) (this is the value of the home in 1993, notice you must enter this as a negative into the calculator.)

PMT (monthly payments) = 0 (there are no monthly payments here)

FV (future value) = ???? (this is what the value should be today if it appreciated at 3.2%)

After entering the information above, the answer is $247,623,62. Meaning that if the property followed the historical rate of inflation that it actually should have sold for approximately $250,000, rather than $210,000. So, while the price of the property today is much more than it was back in 1993, it is actually "cheaper" today than it was in 2017 as the buying power of the dollar relative to the price is better today than it was in 1993.

So, at what rate did this property appreciate?  Let's find out.

Answer: (input the following into your HP10bii Financial Calculator)

N (number of months) = 288 (24 years x 12 months/year)

I/YR (interest rate/year) = ??? (this is what we are solving)

PV (present value) = (115,000) (this is the value of the home in 1993, notice you must enter this as a negative into the calculator.)

PMT (monthly payments) = 0 (there are no monthly payments here)

FV (future value) = 210,000 (this is what the home sold for recently)

The answer is 2.51%. So, the property appreciated at a rate of 2.51%, or .7% under the historical rate of inflation of 3.2% and half of the rate of appreciation compared to the Los Angeles home. This ultimately means that the value of the property, even though it is nearly double what it was in 1993, is really "cheaper" today than it was in 1993, as it increased at a rate lower than inflation. Thereby, hurting the favorite "when I was a kid" story for this particular home.

In closing, while prices might be higher today than they were in the past, that does not mean things are necessarily "cheaper" today than they were back in the day. To determine whether something was truly cheaper, there are a number of factors to consider, the most important is how does the increased price compare to the rate of inflation. The inflation rate gives people the ability to compare prices of properties/goods across time periods. So, next time someone starts to reminisce about the "good ol' days" and how things were so much more affordable than they were today, make sure that you have your financial calculator handy.

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