Today, in Pomona decent homes are selling for $169,000 or even $150,000, akin to prices 10 or even 20 years ago. For homeowners whose major wealth is tied up in their homes, what are we to think? The market right now is crazy, offering fabulous bargains to home buyers. What about the home owners, especially those who are under water? Aside from this volatile time, what are homes really worth? What’s a good way to account for a home’s value?
We all know about comps. Right now, comps are going one way–down, down, down. Should home owners, especially those who are underwater, look only at comps when they decide whether to stay in their homes or get out? Or, is there an alternate way to figure out what a property is really worth?
Traditionally, according to Gary Smith of Pomona College in his book Houseonomics, housing economists relate home prices to rents in a way similar to stock analysts checking price to earnings [p/e] ratios. When a stock price is high with relatively low earnings, that’s a signal of an over-priced stock. Comparing home prices to rental rates, the home’s “earnings”, can also give us a clue about home values.
It sounds hard and mathematical, but it’s simple.
Figure the median rent for a specific type of home, say a 3-bedroom, 2-bath, 1400-1800 square-foot-home in a specific town or ZIP code. Depending on condition and location, such a home in a god school district around here that could command from $2000 to $2600 per month. Let’s say such a home is currently listed for $550,000. Is that home a good buy?
Figure out the p/e for that house. Let’s say it would rent for $2300 per month. Multiply by 12= $27,600. Now divide that into the asking price of $550,000=19.9. Considering the median home p/e is about 16 in a normal market, that is sky high. Even if the rent were at the top of the market at $2600 X 12=$31,200, dividing that into $550,000 still results in 17, also too high. What should the price of that home be? $2300 x 12=27,600 x 16=$441,600 or less.
In today’s market, a buyer might not be willing to pay that much for it, depending on the comps. if a you already own the home, think of it this way: It’s worth keeping if it’s p/e is 16 or above.
According to Celia Chen of Moody’s Economy.com, during the housing bubble, p/e rates of 25 were common across the country, though now as prices are dropping, it’s down to a median of 20. Of course, different parts of the country have different median p/e ratios. New York’s is super high, for example, and so is San Francisco’s.
Eventually, as the market stabilizes over time and fewer homes are on the market, p/e ratios will rise. For now, though, it’s one criterion among many we can use to figure the value of a property.