IrvineRenter_IHB
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[quote author="columbussquare.com" date=1223251848][quote author="IrvineRenter" date=1223206865]It is clear that the volatility in prices in California are not driven by fundamentals. Fundamentals do not change as rapidly as prices do here. There is no variable that correlates with pricing which is part of the evidence for irrationality. When prices crash, they always fall down to levels consistent with historic norms for price-to-income, price-to-rent, debt-to-income, and other ratios closely approximating rental parity. This is strong evidence of a fundamental valuation underpinning the market. If there were no reliable variables consistent at market bottoms, the entire market pricing system would just be speculative noise. Since there is a fundamental valuation to which the market periodically returns, people who pay in excess of this valuation are likely to get burned.</blockquote>
I too believe that prices are based on fundamentals we just make different conclusions on current pricing. The problem that I have with basing prices entirely on "price-to-income, price-to-rent, debt-to-income, and other ratios closely approximating rental parity" is that it values the asset as a "current asset" not a "long-term" one. This is like saying the house will disappear as soon as you stop living there.
When valuing a publicly traded company you look at the fundamentals like price-to-earnings, current ratio, earnings per share, return on assets, etc. But the reason that stocks haven't traded at these levels since 1974 is that the "potential" is "priced into the market". When a stock it trading at earnings it's often a red flag that something is seriously wrong with the business and/or industry. It's really in trouble when the book value of their assets is greater than their stock price. Then they're subject to a hostile take-over and broken up for the parts (see the movie Wall-Street).
I've walked into a number of homes that are REOs. 90% of the ones that I saw had tens of thousands of dollars in damage and deferred maintenance including one house that had all fixtures removed including the water heater. Yet this house was impacting the "comparable sales" and even though it wasn't "comparable" it helps to prove your point that we're moving closer to approximating rental parity.
I believe that we should know what the overall market is doing but make decisions for buying and selling based on the specifics of individual properties and the financing available (we will see more seller <a href="http://www.searchlightcrusade.net/2007/03/seller-carryback-financing-iss.html">carry-backs</a> soon). The closer to rental parity the lower the risk for the purchase or investment.
Everyone should look at the ratios (including cap rate) and compare properties on how expensive they are based on the fundamentals. But don't just use purchase price, you also need to add to the mix additional expenses for one property that another doesn't have (i.e. HOA dues), you also need to look at financing costs (and not just the rate, the points, fees, etc) - when in doubt ask for a Good Faith Estimate or see if a mortgage broker will tell you the spread between interest rates as described in discount points or YSP (yield spread premium). Judge every property that you're considering academically and determine which ones are "cheaper" and which ones are "more expensive" not based on price but as compared to fundamentals. (i.e. a $700k house may actually be "cheaper" than a $400k house based on this analysis but it does require more resources to purchase). You can also do this same exercise with one property over time and you'll see how it changes.
Big purchases are often emotional ones but if you balance that out with "the numbers" you'll find out if you're getting a good deal or not. My view is that the fundamentals with no multiplier is the lowest price range available unless the property is damaged or in disrepair. Accounting for the potential uses or alternative use (i.e. personal residence, rental, etc) and variance in business models (i.e. seeking rezoning or having it already zoned for another more valuable use, redevelopment of a property in a great location - these are often called "tear-downs", a remodel, an addition, marketing it as a rental to different target markets - they don't all pay the same, etc) the price will most of the time be higher than the rental parity (and rightly so).</blockquote>
The basic premise underlying your notion of a value greater than rental parity is that there is an <a href="http://www.irvinehousingblog.com/blog/comments/investment-value-of-residential-real-estate/">investment value to residential real estate</a>. I have run these numbers using discounted cashflow analysis, and the investment value is not very large. In fact, it is grossly overestimated by most participants in the market. This is the root cause of irrational exuberance that causes significant pricing bubbles. Irrational exuberance is a self-fulfilling prophecy. The more people that believe it, the more people act on it, and it drives prices higher. This might be considered a "normal" feature of market pricing creating a new fundamental if it were sustainable. Unfortunately, every time the market inflates beyond rental parity, it crashes back down to these levels. If it didn't, there would be a new variable we would all be able to point to as the fundamental value. Check out today's post: <a href="http://www.irvinehousingblog.com/blog/comments/fundamentals-at-a-market-bottom/">Fundamentals at a Market Bottom</a>.
I too believe that prices are based on fundamentals we just make different conclusions on current pricing. The problem that I have with basing prices entirely on "price-to-income, price-to-rent, debt-to-income, and other ratios closely approximating rental parity" is that it values the asset as a "current asset" not a "long-term" one. This is like saying the house will disappear as soon as you stop living there.
When valuing a publicly traded company you look at the fundamentals like price-to-earnings, current ratio, earnings per share, return on assets, etc. But the reason that stocks haven't traded at these levels since 1974 is that the "potential" is "priced into the market". When a stock it trading at earnings it's often a red flag that something is seriously wrong with the business and/or industry. It's really in trouble when the book value of their assets is greater than their stock price. Then they're subject to a hostile take-over and broken up for the parts (see the movie Wall-Street).
I've walked into a number of homes that are REOs. 90% of the ones that I saw had tens of thousands of dollars in damage and deferred maintenance including one house that had all fixtures removed including the water heater. Yet this house was impacting the "comparable sales" and even though it wasn't "comparable" it helps to prove your point that we're moving closer to approximating rental parity.
I believe that we should know what the overall market is doing but make decisions for buying and selling based on the specifics of individual properties and the financing available (we will see more seller <a href="http://www.searchlightcrusade.net/2007/03/seller-carryback-financing-iss.html">carry-backs</a> soon). The closer to rental parity the lower the risk for the purchase or investment.
Everyone should look at the ratios (including cap rate) and compare properties on how expensive they are based on the fundamentals. But don't just use purchase price, you also need to add to the mix additional expenses for one property that another doesn't have (i.e. HOA dues), you also need to look at financing costs (and not just the rate, the points, fees, etc) - when in doubt ask for a Good Faith Estimate or see if a mortgage broker will tell you the spread between interest rates as described in discount points or YSP (yield spread premium). Judge every property that you're considering academically and determine which ones are "cheaper" and which ones are "more expensive" not based on price but as compared to fundamentals. (i.e. a $700k house may actually be "cheaper" than a $400k house based on this analysis but it does require more resources to purchase). You can also do this same exercise with one property over time and you'll see how it changes.
Big purchases are often emotional ones but if you balance that out with "the numbers" you'll find out if you're getting a good deal or not. My view is that the fundamentals with no multiplier is the lowest price range available unless the property is damaged or in disrepair. Accounting for the potential uses or alternative use (i.e. personal residence, rental, etc) and variance in business models (i.e. seeking rezoning or having it already zoned for another more valuable use, redevelopment of a property in a great location - these are often called "tear-downs", a remodel, an addition, marketing it as a rental to different target markets - they don't all pay the same, etc) the price will most of the time be higher than the rental parity (and rightly so).</blockquote>
The basic premise underlying your notion of a value greater than rental parity is that there is an <a href="http://www.irvinehousingblog.com/blog/comments/investment-value-of-residential-real-estate/">investment value to residential real estate</a>. I have run these numbers using discounted cashflow analysis, and the investment value is not very large. In fact, it is grossly overestimated by most participants in the market. This is the root cause of irrational exuberance that causes significant pricing bubbles. Irrational exuberance is a self-fulfilling prophecy. The more people that believe it, the more people act on it, and it drives prices higher. This might be considered a "normal" feature of market pricing creating a new fundamental if it were sustainable. Unfortunately, every time the market inflates beyond rental parity, it crashes back down to these levels. If it didn't, there would be a new variable we would all be able to point to as the fundamental value. Check out today's post: <a href="http://www.irvinehousingblog.com/blog/comments/fundamentals-at-a-market-bottom/">Fundamentals at a Market Bottom</a>.
), all of the purveyors of frozen yogurt are invited by bk to answer similar questions. Would they make and sell a serving of their product for $1? What about $1.50, $2, etc... Numbers are tallied for each price point, and again cantaloop pays for the valuable data.
