What’s the value of a home? 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 buy homes near good paying jobs. Their salary determines how much home 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.
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 ago banks were making subprime loans left and right. If you could afford the teaser rate, you could buy a house. The increase in demand drove prices up above the realistic values. No one worried about what would happen when the rate increased. They assumed that prices would continue to rise and a home loan would be available. But of course artificially inflated prices can’t last forever. 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.In addition to that, the many forclosures and distressed properties on the market drove prices down below their values.Now potential buyers want to wait until prices have bottomed out. But when will that happen?
History has shown that the market will overcorrect. Just as optimism and easy lending drove prices too high, fear will drive prices too low. When will the decline 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, 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.
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. There are still a lot of distressed properties and foreclosures 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 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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