What’s the value of a house? Of course prices change over time, but there should be a standard formula for determining the value of a home. Like anything else, it’s determined by the benefits its owner receives. The physical characteristic of the house aren’t the deciding factor in price, or homes in Georgia would command the same prices as homes in San Jose. To a large degree, it’s related to availability of jobs. People will move to where there are good paying jobs. Their income determines how much house they can afford. Even within a metropolitan area, homes with shorter commutes to employment centers command higher prices. So there should be a formula of what homes are worth in a given area. Economists have developed such a formula, and determined that prices do tend to move in the direction of the realistic value over time.
So we should be able to figure out the actual value and buy a home for that price? Right? Not exactly. In the short term prices fluctuate according to other factors, such as lending practices and consumer optimism. A few years ago banks were making subprime loans left and right. If you could sign documents saying that you had the income to afford the teaser rate, you could buy a home. The increase in demand drove prices up above the realistic values. No one worried about what would happen when the rate increased. They assumed that prices would continue to rise and home loans would be available. But as we all know, artificially inflated prices can’t increase indefinitely. When mortgage payments on those subprime loans increased, it all started crashing down.
A market correction was definitely in order, but as we often see, it went too far. The banks didn’t just stop lending to buyers who can’t afford the loans and go back to more traditional lending models. They made the requirements so stringent that even buyers who could qualify during ‘normal’ times couldn’t get a loan. And a flood of foreclosures and distressed properties drove prices below their correct values. Now no one wants to buy until they know that prices have bottomed out. But when will that be?
Historically, we know that the market will overcorrect. Just as optimism and easy lending drove prices too high, fear will drive prices too low. When will prices stop falling? A few savvy buyers will realize that the prices can’t go much lower, and they won’t be able to resist the bargains any longer. If you can buy something for less than it’s worth, you come out ahead – even if someone else gets the same thing for a dollar less the next day. Once it starts, an avalanche of buyers will join in and prices will rise. Most of us won’t know that has happened until months after the fact.
Economists are starting to tell us that residential real estate is undervalued in many, but not all, cities. Which markets, you ask? The areas that soared far above their real values are now reduced to bargain prices. Global Insight reviewed Southern California real estate prices and determined that homes in LA are 6.4% undervalued, Orange County real estate is 10.9% undervalued, homes in Riverside-San Bernardino are 15.7% undervalued, and San Diego homes are 21.2% undervalued.
Does that mean you should rush out and buy a home in San Diego or Riverside?Well, it depends.Even within an area, the market is different depending on the segment. Currently there are still a lot of foreclosure properties on the market, mostly starter homes. At the same time, higher end homes are relatively scarce. If you’re looking for a condo, you might want to wait a little longer. If you’re looking for a move up home, there are some great bargains.And now interest rates are phenominally low and there are great tax incentives available to first time buyers and new home buyers.
