How much is a house worth? Of course prices fluctuate, but somehow there should be a standard way to determine the real value of a house. It turns out that like anything else, it’s related to the benefits that come with it. The house itself is not the largest factor, or even the most important factor in price. To a large degree, it’s related to availability of jobs. People will buy homes near good paying jobs. Their income determines how much house they can afford. Even within a metropolitan area, homes near employment centers are worth more than those in outlying areas. Logically, there should be a way to calculate a home’s value based on its location. Economists have come up with such a formula, and it turns out that prices do tend to move in the direction of the correct value over time.
If this is true, we should be able to do the math and go out and buy a home for its actual value? Right? Not exactly. In the near term prices fluctuate with other factors, like availability of funds and buyer and seller expectations. A few years ago banks were making subprime loans left and right. Anyone who could qualify at the teaser rate based on stated income could buy a house. The increase in demand drove prices up above the realistic values. Nobody gave much thought to what they would do when the rate went up. 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.
The market correction was necessary, but as often happens, it went too far. The mortgage lenders didn’t just revert to more traditional requirements. They made the requirements so stringent that even buyers who could qualify during ‘normal’ times couldn’t get a loan. On top of that, forclosures flooded the market, driving prices below their values. Now potential buyers want to wait until prices have bottomed out. But when will that be?
As it has in the past, the market will overcorrect. Just as we got carried away with optimism when prices were increasing, fear will drive market value too far the other way. 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 are able to buy something for less than it’s worth, you come out ahead – even if someone else gets the same thing for a little less the next day. Once it starts, an avalanche of buyers will join in and prices will rise. Most would-be buyers won’t know that’s happened until months later.
Economists are starting to tell us that residential real estate is undervalued in many, but not all, cities. Which areas are those? The areas that saw unrealistically huge price increases are now suffering the largest declines. In a review of Southern California real estate prices, Global Insight said that real estate in Los Angeles is 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.
So, should you go out and buy a home in Riverside or San Diego? Well, it depends. Even within an area, the market is different depending on the segment. Currently there are still a lot of distressed properties on the market, mostly starter homes. Meanwhile, move up and higher end homes are in short supply. If you’re looking for a starter home, now might not be the right time. If you’re looking for a move up home, there are some great bargains. And now interest rates are phenomenally low and there are great tax incentives available to first time buyers and new home buyers.
