Thursday, November 15, 2007

Finally: Some Truth in Real Estate Projections

Most of the articles about real estate prices are sunny, projecting a quick pricing rebound in all local markets by late 2008. The majority of these media items almost read like a press release from the real estate industry, regularly quoting NAR and other stakeholders who have an interest in positive spin on the deteriorating situation.

Finally an article has come out that looks at the cold, hard facts and attempts to perform some realistic real estate market evaluation based on math. A recent article in Fortune projects the prices five years from now using the most reliable indicator of all, price-to-rent rates. The results clearly demonstrate that the quick recovery jubilantly projected by the real estate industry is fiction, and homeowners better be prepared for a multi-year cycle of pain.

Price-to-Rent rates are like a P/E for home prices. Similar to P/E’s for stocks, the price-to-rent ratios are mean reverting, and will always eventually come back to the mean once a speculative real estate market bursts. From 2000 to 2007 the nationwide P/R jumped from 15 to 24, an increase of 60%; this steep climb is not sustainable, and housing prices will eventually correct or rents rise to properly remedy the situation. Performing P/R calculations brings some disturbing conclusions; real estate will have to drop in price by an average of 16% across all markets to reflect proper pricing. This includes the expectations of increasing rents. Some local markets will show far worse downside performance.

The results for 54 areas around the country can be found in this table:

On average, a home that sells for $436K will drop in price to $372K five years from now. A house in San Francisco will be worth $1,568M in five years if the current value is $1,732M. In Raleigh, a house currently valued at $447K will be worth $381K in five years.

The information demonstrates that the real estate price decline is likely to last for a significant period of time, now that the era of lax lending standards has come to an abrupt halt. In the long run, the return to traditional lending standards and non-speculative valuation is a solid positive for the economy. However existing homeowners need to be able to deal with some valuation pain over the next few years as the situation corrects itself.

Real Estate: Buy, Sell, or Hold?
by Shawn Tully
Thursday, November 15, 2007,-Sell,-or-Hold