How much is a house worth? 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 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 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. There are such models, and they tell us that prices tend to move in the direction of this 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 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 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.
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. And a flood of foreclosures and distressed properties drove prices below their correct values.Now buyers are waiting until they’re sure that prices have hit the bottom. But when will that be?
Historically, we know that 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 smart buyers will realize that the prices can’t fall much more.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, then more buyers will join in and the prices will start increasing. 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, you ask? The areas that saw unrealistically huge price increases are now suffering the largest declines. 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.
So, should you go out and buy a home in Riverside or San Diego? It depends. Even within a geographic market, the situation is different in various market segments. 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 condo, you might want to wait a little longer. If you’re looking for a move up home, there are some great bargains.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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