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. It’s not just about the house itself, or homes in New York wouldn’t be worth so much more than homes in Idaho. 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 in a metropolitan area, homes that are more centrally located are worth more. So there should be a formula of what homes are worth in a given area. 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.
So we should be able to figure out the actual value and buy a home for that price? Right? Um, no. In the short term prices fluctuate according to other factors, such as lending practices and consumer optimism.A few years back, lenders were making stated income 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 they could get a new mortgage loan then. 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 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.And a flood of distressed properties and forclosures drove prices well below their values.Now buyers are waiting until they're sure that prices have hit the bottom. But when will that be?
As before, market prices will overcorrect. The same way that excessive optimism pushed prices too high, fear will push them too far down. When will the decline stop? A few smart buyers 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 home buyers won't know this has taken place 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, you ask? The areas that soared far above their real values are now reduced to bargain prices. 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? 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. 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 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.
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