Buying a home and the principle of regression

Buying a home and the principle of regression

When you think about it, there's a good chance that you won't live in the same house for the rest of your life. With this in mind, it's important to buy a home that has an excellent chance of increasing in value over the next decade or so. One consideration when trying to predict future home prices is the principle of regression.

The principle of regression simply states that a home which is significantly more expensive than the other houses in the same neighborhood will be less likely to increase in value over time. When people look at buying a home, they look at the entire neighborhood. If you paid $250,000 for a house but are surrounded by homes which cost less than $175,000, this makes your home seem overpriced. Most people, after all, are looking for a good deal, and they don't like the idea of paying too much for their next home.

Your home may seem overpriced when compared to the other homes in your neighborhood, even if your house really does have extra features. You can do significant treatment like completely redoing the kitchen cabinets or buying beautiful wood floors and marble tiles. Unfortunately, the principle of regression tends to put a ceiling on the future price of your home. You can insist to everyone that you paid tens of thousands of dollars for your improvements, but prospective buyers will probably not want to pay the extra costs.

Again, let's say you're surrounded by houses that cost about $175,000. Yours was more expensive at $250,000, and then you put in $50,000 worth of improvements. It is very unlikely that a prospective buyer would be willing to pay the $300,000 that you put into your home, even if you can prove that the improvements were worth this amount. If the family purchases a $300,000 home, they will probably want to be surrounded by other homes of the same or similar value.

You can think of your home like a cup, and this cup can only contain so much value based on the overall sales prices in your neighborhood. If you spend too much money and over improve the property, your cup becomes full and will overflow.

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