Monday, February 2, 2015

The Price Umbrella in Housing

  It's important to understand the price umbrella if you're going to build a house or otherwise invest in single-family housing.  Most residential neighborhoods in large cities can be categorized as either 1] very desirable, 2] desirable, 3] less desirable, or 4] undesirable.  Generally speaking, the price umbrella for a neighborhood is set by another neighborhood in the same city that is one rung up on the desirability ladder.  Thus, when the prices in a very desirable neighborhood increase, they make room for price increases in neighborhoods that are merely "desirable."  As an example, I will use two neighborhoods in the same part of Texas (full disclosure:  I'm a Texan).

Area A is a well-known upscale area.  Most of the homes for sale in Area A are priced at over $1m.  The public schools are excellent, crime is very low and, most importantly, the residents are either wealthy and/or have "top 1%" jobs, so in all likelihood home values are safe and will probably continue to increase with the incomes of the top 1%.

Contrast that with Area B.  Nice, but not quite as upscale as Area A.  Fewer than 40% of the homes are priced at or over $1m.   The public schools are good, crime is low and most of the residents have "top 5%" jobs.  Like Area A, home values in Area B are safe.

The price umbrella indicates that the potential opportunity here is to buy a lower-tier home in Area B, upgrade it but stay below $1m, and sell it.  Sounds simple, right?  Seems like common sense, right?  And yet, I have seen many professionals -- savvy investors and homebuilders -- violate this guideline by building well above $1m in Area B, and live to regret it.  They either didn't know about, or forgot about the price umbrella.

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