I don’t believe, in July 2007, it was difficult to predict we were nearing a local peak in housing prices.

Obviously it wasn’t. People had been doing it for over 5 years by that point! ;-)

I agree with all of your points, but another big reason to not buy when rates are low, is that you can refinance the loan later if interest rates go down, but you can’t reprice the house after you buy it.

I don’t believe, in July 2007, it was difficult to predict we were nearing a local peak in housing prices. Fundamentals were screaming out loud, and CA was providing a clear indication of Seattle’s future. Of course, a lot of crazies were loudly claiming “Seattle was special” and wouldn’t experience a correction.

By contrast, numerous people without a vested interest in selling houses were talking economic sense at that time. For instance, Patrick over at patrick.net has been a beacon of common sense debunking much of the deciet being memed out to the uniformed public. A great example is his debunking of one of my favorite classic RE cons, which is meant to rush unsuspecting victims into buying before they have a chance to think–the old “interest rates are going up” con. Patrick points out:

‘It’s a terrible time to buy when interest rates are low, like now. Realtors just lie without shame about this fundamental fact. Prices fall as interest rates rise, because a given monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. To buy at a time of very low interest rates is a mistake.
It is definitely far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.

First of all, your property taxes will be lower with a low purchase price [with respect to CA].

Second, a low price gives you the ability to pay it all off instead of being a debt-slave forever.

Third, prices will definitely fall as interest rates rise — so paying a high price may trap you “under water”. Then you will not be able to refinance, and won’t be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. A low price minimizes this possibility.”

RE: Kary L. Krismer @ 49 –

Kary- read the first sentance: “when prices are rising…” And remember, the discussion is about current methods of valuation, not 2007.

Are prices rising now? Or don’t we know, what with so much being “unknowable?” At least to some.

That’s why I picked July 2007. Prices were still rising. Assuming it would continue to go up had no more validity then compared to assuming it will continue to go down today. Price trends do change direction.

The only thing that made valuing property easier, from an agent’s point of view, in a rising market was that if you were slightly high the market would catch up rather than fall further away. But regardless of whether the market is heading up or down, the value of a house that sold yesterday isn’t the value of it today.

RE: silver9 @ 54 – “I can understand why someone would pay a slight premium to own a home (often you pay a lot more than you expect due to maintenance and repairs) but I find it hard to believe people will pay 2x or more for very long. ”

Then why don’t bookstores go out of business when a public library is a few blocks away?

You are comparing a hotel room to home ownership.

Then why don’t bookstores go out of business when a public library is a few blocks away?

It gets right to the heart of how people decide about housing and shows some of the convoluted thinking people have as well as the way folks rationalize overpaying.

I personally look at the rental value which has been completely out of line with actual prices recently. To me rental and construction appraisal methods are closer to price fundamentals than comparable sales are.

I can understand why someone would pay a slight premium to own a home (often you pay a lot more than you expect due to maintenance and repairs) but I find it hard to believe people will pay 2x or more for very long.

Kary- read the first sentance: “when prices are rising…” And remember, the discussion is about current methods of valuation, not 2007.

Are prices rising now? Or don’t we know, what with so much being “unknowable?” At least to some.

Oh, so I guess those who bought in July, 2007 are safe because they bought when prices were still rising, and thus have a guaranteed floor that is no lower than what they paid, right? ;-)

Touche’! But when conventional lending dominated and most single family homes were owner occupied (ie pre-speculative bubble), single-family homes neither appreciated nor depreciated very fast. Barring a major external change (GM closed down the local plant, new overpass build through the neighborhood), you could generally buy a house and not worry a great deal about losing your shirt.

I disagree that a desirable neighborhood will increase at a rate different from inflation, if the desirability of the neighborhood doesn’t significantly changes. Put another way, the desirability of a neighborhood was priced into the home initially, and will continue to be priced into the home in the same way, as long as the neighborhood keeps a similar level of desirability.

This is a common fallacy that Shiller addressed in his book. More desirable areas are more expensive, but they appreciate at the same % rate as less desirable areas. But in defense of Kary, I’m not sure that is what he was saying…

The common counter-arguments are:

- All real estate is local: True, but long-term trends only deviate in rare cases (a city/neighborhood really needs a change of status for this to happen, i.e. city becomes a world class city, or a city dies (Detroit))
- Recent history: My claim is that long-term pricing of real estate follows inflation; but shorter-term, i.e. periods of 10-50 years may have bubbles or depressions. We’ve just seen one!

I’d say the “value” of a home is really just a function of 3 main factors:
1) Local aspects (location, condition, design, construction)
2) Wages (which is more or less a proxy for inflation)
3) Credit availability and multiples

- In an affluent neighborhood, generally the “local” factors don’t change significantly. A craftsman will remain a craftsman; generally condition is maintained; a good location generally remains a good location. Obviously some individual units can decay or not be maintained (while others will be upgraded), but its relativily rare for an affluent neighborhood to completely go downhill (there’s always exceptions; i.e. Detroit). i.e. Queen Anne has been a desirable neighborhood for the history of Seattle.

- Wages generally follow, on average, the rate of inflation. The key here is “on average”. Some industries might get devastated, but typically a new one will spring up to take its place. But GDP/population is generally proportional to inflation. If there’s significant wage changes in an area, that will affect the local inflation and in turn cause housing prices to change.

- Credit: The availability of credit can change, as recently witnessed in the housing crisis. During the runup years, I understand that borrowing power went up 2x to 3x. In real (inflation adjusted terms), its probably closer to 2x, and I would content the easy availability of credit was really the sole contributor to the real estate run-up locally. Now that’s unwinding, and we’ll see the housing prices scale back similarly.

I disagree that a desirable neighborhood will increase at a rate different from inflation, if the desirability of the neighborhood doesn’t significantly changes. Put another way, the desirability of a neighborhood was priced into the home initially, and will continue to be priced into the home in the same way, as long as the neighborhood keeps a similar level of desirability.

-Ross

As I noted when prices are rising you have a repeatable sales point, or floor to work from. It may not be the most you can sell for, but it is a guaranteed price.

Oh, so I guess those who bought in July, 2007 are safe because they bought when prices were still rising, and thus have a guaranteed floor that is no lower than what they paid, right? ;-)

Seriously, the future is uncertain, has been uncertain, and will be uncertain. What a property is worth now, or was worth in the past never is a guarantee of what it will be worth in the future. The only thing certain is that the price will go up, down or stay the same.

So I repeat–all you ever have is temporary data points. Value is dynamic.

Not true. As I noted when prices are rising you have a repeatable sales point, or floor to work from. It may not be the most you can sell for, but it is a guaranteed price. When prices are falling no one knows where the next sale can take place. How far down do you need to go?

RE: ray pepper @ 31 –
Oddly enough, it’s fair to say that any sales price in a declining market is too high, and only guarantees a loss.

Good point that I’ll illustrate with an example. A good friend owns two small houses in the Gallatin Valley (Bozeman, MT). He and his now wife both owned homes prior to marriage. Then his career took him to WA state. Rather than sell the Bozeman houses, he decided to rent them both out as they were cash flow positive. Then he bought a house in his new location with the mortgage payment roughly equal to equivalent rent.

Problems: (1) The value of his most recent house has declined by 20%+ and he is now underwater. (2) He didn’t fully account for maintenance, taxes, insurance, etc… relative to rent; (3) Those cash flow positive rentals in Bozeman are now alligators as rents have fallen ~30% (massive overbuilding); (4) His position here in WA state is not very secure due to the state budget cuts.

No exotic mortgages, frugal living, no cash-out refinancing, etc… But this guy is really struggling financially. In a collapsing market, rents as well as purchase price can fall… so who knows where the bottom will set in. For most of Seattle there simple isn’t enough inventory for this to happen, but I would be very nervous about a condo investment even if the price/rent ratio made sense.

RE: Ron @ 37 – It’s interesting you mention that.

But now we have stuff that was originally planned as condo, or apartments that were renovated to go to condo, being switched to apartments. That has to be really improving the selection.

Yes, selection is way up… BUT given how many accidental landlords are out there, you have to be very careful.

Real Estate is a constant. It’s value is when it’s paid off. The bank, your mortgage, is the enemy. You get rid of the mortgage as quickly as possible. Interest rates and what the bank is doing goes to how the Note will be paid and in what time frame.

Real Estate is worth what it will rent for.

The bank knows that. The lenders and investors who buy the Notes know that. So why are they so surprised today? Why did banks lend more than what property is worth?

You can debate all kinds of wild theories about how to value property, but banks, lenders, and investors know the only value is the income value.

Agreed that the strongest consideration should be given to what the house will likely sell for when you want to move on. This is probably the best way to value a property in a declining market where both values and rents are trending down. While rents/multiples and some minor consideration for emotional benefits have traditionally been the most consistent valuation tools, neither really work in markets where prices, rents, and disposable income are all falling. Until a sustainable bottom appears, I’d say there is no such thing as a real value established, only data points on the downward slope. What we see in current sales prices aren’t really “values” but temporary intersections, markers of completed transactions. They are almost immediately invalidated though- continually falling prices suggest that the same or similar transaction will almost certainly never happen at that price point again. At least when prices are rising you have a floor to work up from, and a price that can be replicated in a subsequent sale. (although it may be sub-optimal.)

In a falling market, comparable sales are non- existent. While you can pick a percentage to subtract from the last comparable sale, it may or may not reflect actual market declines, especially in the current environment. Rents are at least somewhat stable, since they’re fixed for the length of the lease, guaranteeing a sustainable valuation going forward.

Oddly enough, it’s fair to say that any sales price in a declining market is too high, and only guarantees a loss.

You’re right, whether you’re someone that was born in America or not; this has absolutely nothing to with the “scientific” economic mess solution. Let’s be honest and pragmatic, we’ve over-built for uncontrolled population with current resource shortages, making it impossible to fund the current uncontrolled debt.

Now, call me a Hater for echoing the same Earthday logic that Martin L King Jr, John Kennedy and even Richard Nixon vehemently supported in America [and its far worse now] and the world….population control. But you’d better call them Haters too and wake up too….calling any scientist a Hater for supporting controlled population in America to support our only real economic mess solution [can you think of another?], makes you liable for a clear defamation of character lawsuit against you.

Our American economic mess’ solution has nothing to do with politics. Depopulation will take at least 20-30 years to implement, so don’t expect a quick fix either, but we must begin now. Thank God, overpopulation is starting to getting more news coverage lately….our denial stage is coming to an end I pray. How can anyone claim to be a real environmentalist fighting global warming and not consider overpopulation a problem? Its totally unscientific and a ludicrous lie.

I was just thinking this morning about how the life of an average apartment renter (as opposed to house renter) had to go downhill in recent years, because even crappy apartments were getting converted to condos. That had to really limit the selection.

But now we have stuff that was originally planned as condo, or apartments that were renovated to go to condo, being switched to apartments. That has to be really improving the selection.

However What’s going to happen in this World Of Musical Chairs– when everyone actually Finds there SEATS in the next 12 Months or So,
THE MUSICAL CHAIR ARRANGEMENT IS GOING TO REARRANGED…

I Know and many of you here also know there is currently a LOT of Apartment Buildings finishing Construction in the next 6-12 months- What About all those Apartment To Condos that need Residents? I don’t see things getting any easier for Real Estate or the Job Market as a whole.. Bottom Line all Real Estate serves the Same Purpose however in this current world and the world coming forward over the next at least couple years its going to be rough for Rental Values and Real Estate Values in general- Commercial isn’t going be spared either.

PERSONALLY: I Think the Blogger: Scotsman .. is Probably or very likely the Most Financially Educated one here Blogging.

Who ever came up with the term Ownership?? What Defines It?? Ownership- Once I start making Payments on A Brand New Car do “I Actually Own It??—

What Happens what I Quite Paying?? Hell “I Own It– —- RIGHT?? Or does the Bank actually Own IT??

Hell- With Fractional Reserve Banking: Do They Actually Even have the MONEY??

We shouldn’t care about price but you are emphatic that prices will continue to decline, with capital letters no less? Okay Ron.

Here is my Analogy- Prices are Based In CREDIT/ INTEREST RATES- OR AVAILBILITY Of LOANS.. More credit and Loans MORE BUYERS Higher the price- This is Why prices are so High to begin with..

Bottom line is that people base there Decisions on Security of there Job and how much they can afford to pay every month.

For every 1% of HIGHER INTEREST= IS EQUAL to $100.00 Dollars higher payment Per Month on every $100,000. Dollars Borrowed..

I Believe We are LIVING IN A WORLD OF DEFLATION.. Currently… this Money the FED Is lending to the Banks is Not for the most part being lended… Why would they lend this money out?? we need any more Strip malls, Home Depo’s or Fast Food Restaurants? BOTTOM LINE THIS ISN’T CREATING INFLATION… Its currently creating DEFLATION.

My take is that Real Estate will not have any chance of any recovery at the earliest for the Bottom is 2012.. anything sooner your not close to a bottom… By that time it will be on the Front Cover of Some major money Magazine Probably Touting it as probably the Worst Investment…. ~!!

RE: David Losh @ 25 – I think it’s absurd to suggest that the value of owning a property is only the rental value. Look how upset people get over government or HOAs controlling what an owner can do with a property. Ownership obviously has greater rights than a mere tenancy, and thus is more valuable. Also, just the certainty of knowing that you are not going to be kicked out if the landlord decides to sell, do something else with the property, or gets foreclosed.

There are advantages and disadvantages to owning vs. renting. Some people prefer to own and others prefer to rent (my guess is that you have a lot more contact with the former group.) Who cuts the lawn, repairs the broken furnace? Who has more flexibility to follow a job? But the predominant value of a house is that you get to live in it! Therefore equivalent rent is a very good basis for estimating the fundamental value of a house. Now, if you REALLY prefer to own, you can pay more than fundamental value. Knock yourself out. But I certainly don’t want government guaranteed mortgages covering that purchase.

This question is more important NOW then ever.

I know I know all you keep telling me “Ray, not everyone sees their home as an investment!” I say BS!! A home PURCHASE is ALWAYS an investment. If you find yourself in a position that you MUST move in this next decade you better make sure what you are Buying is a GEM!

Now go find them!

You will know when you get one!

http://www.cnbc.com/id/15839285

Kary, we are talking about when people are out looking to buy a home. There is no discussion here about renters and home owners.

Rental income valuation is a simple quick and easy measurement for getting a rough idea of what a property is worth. You can add and subtract from that base value depending on your abilities and wants in a property.

Most people have limited access to fair market valuation by CMA and even if they did it would be moot to fair market value. Housing units are over priced.

Some properties do have intrinsic value. Some properties are like comparing a 1957 Chevy to a 2009 Prius, but even at that there is a base price to be determined before you offer whatever the market will bear.

It’s how we got into this mess. People bought by CMA calculations.

I’d love to hear what forumlas people have been using for this. I have a few “back of the napkin” calculations that take into account increase in incomes, whether the neighborhood has improved, rental rates and interest rates.

Each of those factors, unfortunately, depend on both the aggregate effects of the bubble and the mid term direction of the economy.

In my opinion we are talking about mom, dad, and the kids looking for the family home. I think people should be asking themselves what they or a reasonable person would rent a place for.

I think that’s the only every day reliable way to make an informed decision. Every one can get familiar with what rents are in a neighborhood. OK, if you want to add or subtract for personal comfort, great, you can base that on the income value approach.

I would also say this is exactly how we got into this over priced mess. Income based valuations are the only way to determine if a property is viable economically. The 20% down payment would cover selling costs, but selling is more problematic than renting.

It’s sort of like how if a given property’s current use isn’t it’s highest and best use, it will be valued higher based on other permissible uses.

When looking at rental property, then rental income is the major concern, but if the property is commercial property next to a rapidly growing company or downtown center, then a savvy investor will be willing to take a loss on rent to make it up in appreciation.

RE: The Tim @ 14 – “â��When you are considering buying a property, how do you determine what is a fair price that you are willing to pay?â��”
Using recent sales data will almost always be preferable to using years old data for predicting the future price, although using both can be valuable to smooth out short term fluctuations.

Long term, price vs. rent ratios are very consistent for individual cities, neighborhoods, etc… Price/rent is analogous to the P/E ratio for stocks, and a useful tool to determine whether a stock is over or underpriced. So if you are truly worried about resale value, looking at equivalent rent is probably your best tool. Looking at comps is like buying dot.com stocks at the peak because everyone else is doing it.

I generally agree that your conclusions. As a matter of fact American law has always recognized that each piece of real estate is unique and therefore a buyer is entitled to the remedy of specific performance rather than just damages when a seller defaults (unless the contract limits the buyer’s remedies). But a loan underwriter should be looking at the value of real estate as collateral for a loan and the aspects of a property that make it uniquely valuable to any particular buyer should probably be given little weight. The property should probably be viewed more like a commodity that can quickly be liquidated like a fugible good to any of a number of buyers. The appraisal is required by the lender for the lender’s use and should probably reflect the lender’s considerations and not those of the buyer.

Incidentally, we bought our current house in 2003 at what I anticipated to be near the top of the market. We bought it the day it came on the market for full asking price and our offer stated that it terminated at 6:00 on that day. There was an open house scheduled for the weekend and I told the listing agent that if they rejected our offer and held the open house any new offer by us would be at a decreased price. I thought the house was over priced at the time but it had unique value for my wife and I for a number of reasons and we were willing to pay a premium for it. By the same token, the only reason we have a mortgage is because I’m egotistical enough to think that I could make more than 5% on the relatively small amount we borrowed.

RE: Groundhogday @ 9 –

You don’t need to adjust for inflation when you talk about 125x rents, because this is expressing a ratio of current dollars. Inflation is irrelevant at this point.

I didn’t say inflation, I said that you need to adjust for interest rates. And yes, you do need to adjust for interest rates because that directly impacts holding costs or opportunity costs.

So I think the way to look at the price of a house is how much I will enjoy it, or how much it will assist me in earning an income, plus consideration of its resale value at some future date. So I care about the resale value, but not the fair value, whatever the heck that means.

It seems to me like you answered your own question there.

There is a fudge factor for the tax considerations.

Real Estate Investors want commercail property. No one wants residential Real Estate except the novice. You have to deal with renters. Renters are difficult. Maintainence is a big issue and expense. It’s a tough way to make a buck and you are tying up your cash for at least fifteen years.

Appreciation is a gift that may be a long time coming back. Also in residential a borrower has limited ability to borrow more. It’s easier to borrow for an apartment building if the numbers look good to an investor than residential.

When I am considering going to a restaurant, I don’t worry about what the fair price for the meal should be. It is just a matter of how much I will enjoy the experience versus other potential uses of the money. A house is a little different, because unless I am sure I will be living the rest of my life in that house, then the resale value is an important consideration. So I think the way to look at the price of a house is how much I will enjoy it, or how much it will assist me in earning an income, plus consideration of its resale value at some future date. So I care about the resale value, but not the fair value, whatever the heck that means. The resale value is what the highest bidder will pay for it, less sales and tax costs. To predict the resale value, you look at what the market is willing to pay for similar properties. Using recent sales data will almost always be preferable to using years old data for predicting the future price, although using both can be valuable to smooth out short term fluctuations.

You don’t need to adjust for inflation when you talk about 125x rents, because this is expressing a ratio of current dollars. Inflation is irrelevant at this point.

I should add that the specific area-wide rent ratio values are somewhat arbitrary, and are only really useful to compare to their own past performance. I strongly recommend against using them as a valuation tool for any specific home or neighborhood.

The whole concept of a “fair price” as distinguished from the actual price is highly suspect.

I think the thrust of my poll question is a little unclear. If I had used more words, I would have said: “When you are considering buying a property, how do you determine what is a fair price that you are willing to pay?”

I don’t think that question is “suspect,” but rather highly relevant. Sorry I was unclear.