Home Valuation Sensitivity Analysis

[irvine123_IHB]

<p>IR posted a spreadsheet several months back to provide a home valuation based on rental value for the period between Jan 2007 and Dec 2012. The conclusion was 39% drop from peak to bottom. The key assumptions were: Home Value to Rental rent multiple of 160; Rental inflation of 3% a year. </p>

<p>In Today's OCRegister, the rental inflation rate is reported to be 6% a year. Assuming one agrees with IR valuation method, I did some quick sensitive analysis. Here are the results:</p>

<p><strong>Scenario A: What if the rental inflation rate is changed to 6% while keep the "home value to rental rates multiple" the same at 160?</strong> </p>

<p>The result:</p>

<p>a. Market will bottom around Oct 2010, the total drop is 32% vs. 39%. </p>

<p>b. If I were to adjust down the rental inflation rate back to 3% once it bottoms out, by Jan 2013, one would have recovered another 3%, to make the <strong>net 2007 to end of 2012 drop to 29%.</strong> </p>

<p><strong>Scenario B: What if the rental inflation rate is changed to 6% while change the "home value to rental rates multiple" to $180</strong> </p>

<p>Result:</p>

<p>a. The market will bottom around Jan 2010, the total drop is 28% vs. 39%. </p>

<p>b. Again if I were to adjust down the rental inflation rate back to 3% once it bottoms out: by Jan 2013, one would have recovered another 4%, to make the <strong>NET 2007 to end of 2012 drop to 24%</strong>. </p>

<p><strong>Scenario C: What if the rental inflation rate stays at 3%, while change the "home value to rental multiple" to 180?</strong> </p>

<p>Result:</p>

<p>a. The market will bottom around July 2010, the total drop is 32% vs. 39%. </p>

<p>b. Due to continued retal inflation at a rate of 3%, by Jan 2013, one would have recovered another 3%, to make the <strong>NET 2007 to end of 2012 drop to 30%. </strong></p>

<p>I am NOT trying to point out the rental inflation rate will be 6% vs. 3% (though I argued about it several months ago), nor am I trying to argue the "right" multiple is 180 vs. 160 (again, many of us argued about what the "right multiple" should be in a separate trend weeks ago. If I remember correctly, the consensus was between 160 to 200). I have no clue what the actual should or might be. </p>

<p>My point of doing this sensitivity analysis is an attempt to "range bound" likely price drop for the next 60 months - 24% to 39%. Also, I am trying to point out if you do your homework, and get a nicely located home with a 25% + discount from the peak comps (NOT 25% from those outrageous asking prices) there might not be as much down side risk as some might believe if you keep the home for longer term. Also, from this analysis, it is unlikely one can find a nice quail hill or woodbury single family home for too much below $300 / sq ft when the air is completely out the bubble. </p>

<p>Just food for thought. </p>

 

[bigmoneysalsa_IHB]

<p>IMHO 160 multiple is a high-end estimate.</p>

<p>1) I believe IR cited this as an approximate break-even point for many owner-occupiers. In past busts prices have typically fallen to the point where they were low enough to attract cash flow positive investors. This would require multiples well below 160.</p>

<p>2) Multiples closer to 100-140 were common in So-Cal in the mid 1980s and mid 1990s, and are common today in many non-bubble markets. It would be suprising not to eventually see them again.</p>

 

[IrvineRenter_IHB]

I discuss this some again in tomorrow's post (11-16-2007). I think there is good reason to believe we will drop down to positive cashflow territory again.





One note I would mention in response to irvine123s thoughtful analysis: Price inflation may rise 6% or more, but I don't think wage inflation will keep up. I believe we are on track for a severe recession locally which will likely keep wages down for a few years. This will in turn keep rents in check.





Also, because of the higher inflation, mortgage interest rates will likely rise which in turn makes the breakeven GRM drop.





I think the area in Irvine which will probably do best will be Turtle Rock. I still think you will see between $250-$300 SF on the few transactions at the bottom in that neighborhood. I think the new communities with their small lots and crowded McMansions will depreciate to under $250/SF. The older neighborhoods like El Camino Real will drop under $200 SF.





Irvine123,





I appreciate that you make a more bullish case. You may be quite accurate in your estimate. Only time will tell.

 

[graphrix_IHB]

irvine123,





Thank you for taking the time to post a more optimistic perspective. And, to be perfectly honest, I would like to see scenario B more than the others. I think if the job market is strong, and real wages increase, that could make that scenario a reality. I may be a housing bear, but I have never wanted a recession, and the other scenarios would mean a recession. Unfortunately that is what I see coming, and of all my predictions, that is the one I would be happy to be wrong on. I would enjoy eating crow on that one.

 

[No_Such_Reality_IHB]

<p>Lasner hinted to that in his blog today. Long term, the rental growth has been 4.3% "on average" . His statement about 5 year intervals is completely wrong though. There nearly 2/3rds of the 5 year periods since the end of the 2nd World War did not average 4.3% annual equivalent rental growth. In fact, in the 50s, 60s, there are long periods were the growth is in the 1-2% range year after year. </p>

<p>The bullish outlook paints the picture that 4.3% is normal and that the mid-90s rental duldrums are unthinkable. The reality looking at the BLS data shows the 90s rental hangover to be quite normal. Probably even expected given the 7-10 years of bullish environment that we've had.</p>