The Economics of House Vs. Land Value
When one buys a home, one is really buying two main components:
1. The House, and
2. The Land or Lot.
All other things being equal, it is better to buy a home in which the lot (as opposed to the house) represents the higher percentage of the total value.
Two Basic Tenets of Real Estate
1. Lots appreciate in value.
2. Houses depreciate in value.
Lot values realistically run from 20% to 90% of the total value of a property. Discounting inflation, the cap on the value of a house is what it would cost to replace it.
Depreciation is the loss in value over time due to wear and tear, evidenced by the fact that most people would rather have a new home than a used one. Conversely, appreciation is the increase in value over time.
There are two homes with the value of $250,000. Property #1 has a house value of $200,000 and a lot value of $50,000, while Property #2 has a house value of $50,000 and a lot value of $200,000.
Property #1 clearly has a much nicer structure on it, while Property #2 has a much better location.
The change in house vs. land value over time demonstrates why it is better to put more money into the lot as opposed to the house.
If the houses on Properties #1 & #2 depreciate by 10% over a 5-year period, the overall value of Property #1 depreciates by $20,000 (10% of $200,000), while Property #2 depreciates by $5,000 (10% of $50,000).
A 10% increase in their respective lot values over 5 years would reverse the math above. Specifically, Property #1's lot appreciates by $5,000, while Property #2's lot appreciates by $20,000.
If you combine both assumptions above, Property #1's net loss totals $15,000, while Property #2's net gain is $15,000 over 5 years. The following details the changes in house and lot values for both properties over a 5-year period.
Property #1 Property #2
House Value $20,000 $ 5,000
Lot Value $ 5,000 $20,000
Net Gain/Loss $15,000 $15,000
If you assume a 5-year time period, the total value of Property #2 increases by $30,000 more than that of Property #1.
Net Difference of $30,000 over 5 years = $6,000 annually, or $500 per month
A Parting Thought
The question then arises: Is it worth $500 monthly to own Property #1 rather than Property #2 for a 5-year period or whatever time frame one assumes.
About the Author
If you have any questions about this information, please contact Harvey at firstname.lastname@example.org. With 30 years of experience as a real estate developer and broker, Harvey shares his unique insights into the dynamic world of real estate in this Blog. He currently lives and works in Austin, TX.