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. 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 commuting distance of employment centers, more centrally located homes 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.
If this is true, we should be able to do the math and go out and buy a home for its actual value? Right? Um, no. In the near term prices fluctuate with other factors, like availability of funds and buyer and seller expectations.A few years ago lenders were making a lot of subprime loans. If you could afford the teaser rate, you could buy a house. The increased demand drove prices up to unrealistic levels. Nobody gave much thought to what they would do when the rate went up. They assumed that prices would continue to rise and mortgage financing would be available. But as everyone knows, artificially inflated prices can’t continue indefinitely. When the teaser rates expired and mortgage payments went up, the crash began.
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.In addition to that, the many forclosures and distressed properties on the market drove prices down below their values.Now buyers are waiting until they’re sure that prices have hit the bottom. But when will that be?
History shows us that market corrections usually go too far before they settle at a correct value. The same way that excessive optimism pushed prices too high, fear will push them too far down. When will it stop? A few smart buyers 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 areas are those? The markets that grew far above their correct values are now suffering the greatest decreases. 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.
Does that mean you should rush out and buy a home in San Diego or Riverside? It depends.Even within a geographic area, conditions differ in various price ranges. Currently there are still a lot of distressed properties on the market, mostly starter homes. At the same time, move-up 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 larger home, there are some deals available.And right now the government is offering tax incentives to home buyers in an effort to get the real estate market moving again and interest rates are at historic lows.