When Not to Trade Four Houses for a Hotel
I'm guessing many folks think the best time to sell your house and move up to a better one is when the market is strong. Housing prices are up and the house you're selling has increased in value. After all, you're maximizing your profit and equity, right?
By the same token, people figure when the housing market is down is no time to trade up, but to hold on and sit tight. Don't want to take a hit selling for a loss, right?
Wrong in both cases. The best time to trade up is when prices go down, and when prices rise is the worst time to trade up. Don't buy it? You can prove it to yourself with this simple exercise using Monopoly money, houses and hotels.
Let's say you start the game with $2,000 and no property. Houses sell for $1,000 and hotels (representing a house twice as good) go for $2,000.
Game One, Constant Prices: On your first turn you buy a house for one thousand dollars, you now have a house and one grand. On your next turn you sell the house back for the same price and now have $2,000, same as you started with. On turn three you buy a hotel for $2,000.
At the end of the game and you end up with a hotel and no money. You spent a grand total of two grand and have a hotel. It's simple math: 2,000 - 1,000 + 1,000 - 2,000 = 0.
Game Two, Rising Prices: On turn one you buy a house for one grand leaving you with a house and one thousand dollars. At this point house values, including hotels, double across the board. Next turn you sell the house back for twice what you paid, $2,000. You now have three big ones and no property. Wow, you really made out, right? Not so fast. On turn three you buy a hotel, but since prices are twice what they were it now costs $4,000.
At the end of turn three you have a hotel, the same hotel as above, and you still owe another $1,000. What happened to that $1,000 profit? In this game you have a hotel, but you had to spend $3,000 overall to get it. It's simple math: 2,000 - 1,000 + 2,000 - 4,000 = -1,000.
Game Three, Falling Prices: On turn one you buy a house for one thousand bucks so you have a house and one grand. At this point house values, including hotels, fall 50% across the board. On turn two you sell the house back for half what you paid, $500. Oh no, you lost 500 big ones! You now have $1,500 and no property. On turn three you buy a hotel, but since prices are half it now sells for one grand instead of two.
At the end of turn three you have a hotel, the same hotel as in game one, plus $500 left over. You only spent a total of $1,500 for the game. What happened to that $500 loss? Even though you lost five hundred on the first house, you're $500 better off than in game one because the hotel is $1,000 cheaper. It's simple math: 2,000 - 1,000 + 500 - 1,000 = 500.
You bought the same house and hotel in every game, yet you spent less overall when prices went down and more when prices go up. See, falling prices are a good thing if you play the game right. Rising prices are a bad deal if you want to trade up. While this was Monopoly money the same works in real life.
Of course, if the game ends after turn two you profit from rising prices. However it doesn't work that way because in real life you have to live somewhere. If you sell the house you're living in you have to buy another. When trading up, if prices stay the same it's a wash, if they rise it costs more, if they go down it costs less. (When trading down the opposite applies. When trading even, it's a wash in all cases.)
If it were only your house gaining and losing value it'd be a different story. When trading houses, values are relative to the market as a whole. The dollar value doesn't equate to replacement value of a comparable house. That's what you should be looking at. The simplest way to think about it, in a falling market you lose money on the house you sell, but better houses have lost more and so are more affordable. It's a net gain. In the meantime you live in whatever house you have, and that's the real value of a home after all.
copyright Terry Colon, 2008