Are real estate price increases linear across a range of prices?

Does that make any sense? Let me give you an example. Suppose in a given neighborhood, the majority of houses sell for between $100K and $400K. A few years later, I read in the paper that the average home price has gone up by 25%. That’s the average, but what happens at the margins?

It seems to me there are a few possible scenarios. All properties could increase in value by the same proportion, ie $100k houses now sell for $125k, and $400K houses are now worth $500k. Or, they could all increase by a set amount, so $100k houses are worth $125k, and $400k properties sell for $425k. Another possibility is that cheaper houses appreciate at a greater rate, since there are more people who can buy them. Or it could be the opposite, that snob appeal drives up the cost of expensive houses.

Although I’m curious to know the answer to this question for its own sake, the fundamental question behind my curiosity is this: If one is buying into a neighborhood where prices are expected to increse, should you buy the most expensive house you can afford, becuse price increases will drive the others out of your range, or can you buy a cheaper house and leverage its gain to move into a more expensive one later?

A rule-of-thumb is never to buy the nicest house in the neighborhood. The theory is that it won’t appreciate at the same pace as the cheaper houses. You should buy the worst place and fix it up.

I don’t know the validity of this in general, but I’ve done it and it worked for me.

Makes sense, though. If we suppose that neighborhood really does make a difference in prices, then there is going to some factor that adjusts house prices based on some sort of averaging (for lack of a better word). The most expensive house would then be pulled down by the average.

Also worth noting is that real estate markets are pretty thin, so you can’t say that the prices are truly informative as they are in thick markets, e.g. stock markets. (See A Random Walk Down Wall Street.) So it is reasonable to think that the most expensive house in a neighborhood is overpriced, or at least there is greater potential for that risk than a less expensive house.

Of course, I’m not an appraiser or an assessor. I work with an assessor, maybe I can get her to bite. She’s pretty busy though, so if I come back with the fact that she replied, “Screw off,” don’t hold it against me.

I think that your assessment is correct NutMagnet. I think that the lower-priced homes have a volatility that the higher-priced ones don’t (the beta, to borrow a phrase from stock markets) and therefore, when prices move (in either direction), they will be affected more than the larger homes, relative to their current worth.

From my limited real estate experience, the neighborhood is always judged by the worst house in the area (unless, of course, you’re dealing with gentrification which has its own strange rules). If nothing else, the value of the property itself is going to rise so that even if it’s a tear-down, you might be able to see some pretty big swings in appreciation. A house down the block from my Mom’s recently sold for $700,000 (I’m pretty sure it’s as a teardown, or at least a massive renovation), which, given prices when we moved in is at least 300% more than it would have gone for (basing it off the value of our house at the time).