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Housing Price Rules-of-Thumb


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2006 Mar 21, 4:17pm   21,698 views  183 comments

by HARM   ➕follow (0)   💰tip   ignore  

perplexed

Truism: while many --though by no means all-- of the regular Patrick.net bloggers are renters, at some point most of us JBRs would like to become homeowners (something the bulls/trolls frequently like to point out). Aside from that oh-so-powerful "ownership" psychology and pro-ownership cultural bias we discussed in previous threads, there are also valid reasons to choose buying over renting in a sanely valued market: it's generally easier to find detached houses for sale vs. for rent in many areas, or places with a big yard or garage, no pet restrictions, fewer restrictions on remodeling (excepting HOAs & condos) and you can't be arbitrarily evicted --unless you fail to pay your mortgage or taxes of course.

Some renters prefer renting to owning, even when the rent vs. buy equation is balanced, due to moving frequently, preferring more freedom/fewer maintenance headaches, etc. But for this thread, I will focus on renters who --for whatever reason-- would like someday to become owner-occupiers (as opposed to landlords or speculators). Personally, I'd be lying if I said I didn't like the idea of owning a nice, roomy tree-shaded craftsman with a big garden and workshop someday. I might be termed an aspiring "buyer-users" (coined by Mike Dwight). The way I see it, many of us Bubble-aware aspiring BUs are either: (a) looking to move out of Bubble-afflicted areas, or (b) waiting for prices to mean-revert. As I often like to put it, we are needing to see "housing prices reflect economic fundamentals" --namely rents and incomes-- before buying.

But how does one exactly determine when prices are "in line with rents and/or incomes"?

For the more financially saavy among us (Randy H, Peter P, Zephyr, etc.) this means feeding reams of housing data into your personal SPARC parallel processing super-computer and generating results using some insanely complex Black-Scholes stochastic risk valuation derivatives model, which would be virtually incomprehensible to the rest of us.

So what do the rest of us mere mortals use? How do we know when it's the right time/price to buy? How do we know when prices have "mean-reverted" enough to be safe?

Some of us use online Rent vs. Buy calculators. These are great, because they can calculate the P-E (rental) ratio of housing with decent precision. Condos and townhomes make direct buy vs. rent comparisons easy, because they are often physically identical/interchangeable with typical rentals units. Calculating the precise rental-equivalent for detached SFRs is a bit harder (unless you live in an area where many are for rent), but rough estimates are always do-able. Here are some good Rent vs. Buy calculators:

Dinkytown.net Rent vs. Buy
CEPR Rent vs. Buy

Others prefer using Cap-rates. Here's a good Cap-rate calculator:

Owner's Equivalent Rent Calculator

Some prefer even simpler rules of thumb:

  • median price is no more than 3-4X of gross median household income (or closer to 5-6X incomes in expensive coastal states)
  • buy when the local HAI (housing affordability index) is at or near it's historic mean value (whatever that is)
  • pay no more than 10X annual equivalent rent (cap-rate = 10 or better)
  • What are your favorite "sane housing price" rules-of-thumb?
    Discuss, enjoy...
    HARM

    #housing

    « First        Comments 168 - 183 of 183        Search these comments

    168   Peter P   2006 Mar 23, 12:11pm  

    Hey guys, what do you guys think of Pleasanton? How would you rate and describe that area? It looks like there’s relatively good value homes there, but how long is the commute to Downtown SF?

    I do not know the area well. What do you mean by good value? Do you mean big house for 1M or super big house for 2M?

    169   surfer-x   2006 Mar 23, 12:15pm  

    1M haha is a lot of money.

    170   Peter P   2006 Mar 23, 12:22pm  

    Peter P, I guess on a price/sqft basis.. pleasanton seems to have houses at around $300-350/sqft?

    What kind of houses? (square footage, lot size, amenities, ...)

    I cannot imagine that the commute to SF can be enjoyable, unless you take BART, which may not be so bad. :)

    171   Phil   2006 Mar 23, 12:52pm  

    @Cheerful - thanks for posting your home deals and the money you made.. everyone wants to make money.. be it by saving real hard or by winning a lottery at the real estate game.. please do continue posting here.. I would like to read what happens in a year or so from now when the housing bubble goes bust or poof...

    I do want the housing bubble to burst... even though i have family around me who have a lot invested in RE.. I would definitely like to have the prices go down to what it was in the 1998's.. but that would require a huge recession and i do fear my job will be at stake... working in the IT for a mortgage banker, I am sure the i will be the first to be caught high and dry...

    someone mentioned about improving and tightening the lending process, yes it would reduce the time needed to buy a property in my opinion...

    172   surfer-x   2006 Mar 23, 1:26pm  

    @nancy, the lowest any company pays in the BA is 1HaHa, aka, 150K. Everyone at every company here gets stock options, you actually use your pets.com stock as legal tender at 120 establishments in Santa Clara. The average janitor at a BA company makes 1.7 million a year, plus countless stock options.

    173   OO   2006 Mar 23, 1:59pm  

    Nancy,

    The median household income is usually an ESTIMATE, not a hard data directly fed from IRS database. Also, it is a median number, not mean. Usually it is a product of the data obtained from the US Census Bureau, State's financial management office and the city's research group. It is mainly a derivation from a financial model that they developed and fine-tuned over time. Contrary to common belief, such data comes from SURVEY data, sampling method and respondents' integrity in answering questions may skew the final result.

    As for incorporation of stock options, it is INCLUDED in the estimate (at least I saw it mentioned in the footnote).

    Is the current median household income data truely reflective of the reality? I think it is as close as it gets, because they do cross check data with different sources.

    174   StuckInBA   2006 Mar 23, 2:39pm  

    Cheerful and wowwow...,

    Congratulations for making money in the RE, and good luck in the future.

    Do you have any suggestions / thoughts to make money investing in this economy / market from this point onwards ? Past performance is no guarantee of future results.

    If you have any ideas other than buying more RE in Idaho, please share with us.

    175   Randy H   2006 Mar 23, 2:47pm  

    Damn, I'm out for a few hours and the fireworks really go off around here.

    @SFWoman,

    OK guys, since I am somewhat new to blogs (this is my first)- how often do Realtors or other people with a vested interest in maintaining very high real estate prices come to this blog and simply pretend to be real estate purchasers who are doing well or who have hit it big? Do they ever get groups to do this? Does Patrick ever produce a list of visitors to this site (I believe I saw one on Athena’s Sonoma blog)?

    I don't think anyone here produces such lists. Athena a different blogging service (blogger I think); this site uses WorldPress which doesn't easily (so I can see) allow what you propose. I use Typepad on my own blog and it doesn't really support this user visits either, but does have a list of who the last few visitors were.

    I'm sure this blog has had at least a couple of colluding spinners, but nothing well coordinated.

    Coordinated blog attacks aren't all that common, but becoming more so over time. Mainly in political arenas, there are organized blogs which exist for the sole purpose of getting a bunch of partisans to all go pile on some influential other blog and skew the sentiment. Also, a bit more troubling, there are at least two startups I know of which have developed pretty impressive natural-language processing/artificial intelligence processes which can auto-blog but appear very much like real people. You can only tell they aren't real in that they appear for a short while, only respond to the thread comments a couple times -- usually only briefly engaging other comments (which are usually also collusive "bots") -- then disappearing. One of these guys is working on actually creating persistent, long-lived virtual blog personalities.

    In fact, maybe I am not real, just an advanced bot. Oh wait, I passed the Turing test because I've made far too many idiotic comments that can only be attributed to being human.

    176   StuckInBA   2006 Mar 23, 2:49pm  

    Wowwow... ,

    Pleasanton is a good area, the commute is bad to South Bay, and OK with BART to SF. In general, the area feels very much new, and clean compared to San Jose.

    But ... I don't think there are any houses in the range of $300-350/sqft there at all. That is simply way off. The "asking" price is in the range of $400-450/sqft. The $300 rate was in 2003.

    Pleasanton inventory is steadily climbing this year. It's not the core of BA, so will fall first.

    177   Randy H   2006 Mar 23, 2:56pm  

    @SGV Patience,

    Speaking for myself (Sans degree at the moment) I believe in my own social mobility as long as I need only care for myself. 27, no kids, no significant debt $20,000 in an investment garnering me 5% a month compounding interest that I can contribute to on the fly. I wonder what you might do in a similar position?

    I think you already know the answer. Invest in your own education and work experience so that you can rely upon your ability to earn an income. Then, once you know you can live life comfortably, react to unseen changes, and deal with unplanned events, invest wisely. I don't give specific investment advice -- not because I don't have an opinion, but because others here are far more capable at doing so than I -- I just try to focus on big picture stuff and how it is important to you.

    Just make sure your investment is diversified according to your own risk tolerance level. At your age, this should be aggressive and long-term. And, don't invest a penny until you've maxed out every possible tax-deferral available to you.

    Just my own perspective. I wouldn't really consider buying a home -- even if there were no bubble -- if I were in your shoes. It's probably worth far more to you to stay flexible. Consider it the price of a real-option. If you can move relatively quickly whether for job, for love, for family, you will probably be far better off than trying to be shrewd by buying a home anytime soon. Once you're tied down, rooted, or perhaps just happy being single and in one place for a longer while, then buying might make sense.

    178   Randy H   2006 Mar 23, 3:11pm  

    @Cheerful,

    Thanks for posting the details of your experience, and as others have said, please continue to post. You won't be labeled a Troll by most of us unless you purposefully incite things without being willing to engage in serious debate. Surfer-X has had a very long, bitter battle with genuine Trolls here for years, so his response is easy to understand. See how your post did bring out another much more "Trollish" response from another commenter.

    Anyway, as to evaluating your situation, all I can say is that ultimately all real-estate transactions are LOCAL. We talk a lot about averages and trends, but it is always possible to find exceptional deals in any market -- just harder in some than others. This is really what the professionals like Zephyr or FormerAptBroker here do well. They have the experience, intuition, and stomach to run profitable RE investment/income businesses.

    What you did was speculate (again, in my opinion), and got lucky. If you take your luck as such and use your gains to invest in learning how to run a RE rental business, then you stand a chance of doing well. If you think your luck was something else, more directly due to your own incredible prowess, then I'm afraid I'm not very optimistic about your future ability to generate returns. And, by the way, X is right that you have not *realized* some of the gains you are claiming. With RE, your gains are not realized until sale or asset restructuring occurs -- until then it's all book value. We don't do fair-price valuation on RE for tax or financial accounting in the US. So unless you're pulling out equity and restructuring the asset, it's still only worth the book value to you now (because you can't tell the future. it could drop to what you paid the day before you sell it).

    Remember this, for a RE income business, or any business for that fact, the value to you is ONLY based on the expectation of future FREE-CASH-FLOWS. This means cash in excess of all capital budgeting needs, operational needs, and working capital. What you have described doesn't give me enough info to evaluate whether you're doing this or not.

    180   Unalloyed   2006 Mar 23, 3:52pm  

    If you think your luck was something else, more directly due to your own incredible prowess, then I’m afraid I’m not very optimistic about your future ability to generate returns

    Another truly excellent post, Randy H.

    181   LILLL   2006 Mar 23, 5:07pm  

    SFWoman
    I think you've got it right. Trolls working together for their own benefit...like con men passing the mark's wallet...

    182   Different Sean   2006 Mar 24, 7:45pm  

    just to flog a dead thread... on the 10x rule, interestingly, there's a 'licensed boarding house' nearby on the market i was looking at, don't ask why – to do with one of my partner's hare-brained business schemes.

    the owners paid $657K for it 2 years ago (bought at the top of the market), have been making a loss on it ever since, prices have dropped, and it's back on the market for '$640K negotiable'. Even at that price, they have lost 17K + the stamp duty and conveyancing costs, so maybe another $20K. Plus the money they've lost every week in the repayment shortfall.

    When you calculate the actual annual rent gathered on it (assuming fully occupied) and multiply by 10, you get $426K. $640K asking is almost exactly 50% over the realistic rule of thumb for a sensible investment (to realistically be able to pay back interest and principal, and not be praying for capital gains to bail you out). Interestingly, a recent OECD report stated that Australian property was 50% overpriced on 'fundamentals'. Uncanny.

    183   ric   2006 Mar 25, 3:39am  

    Just want to note that Cheerful was in all likelihood quite confident that when his 1.2 haha stock market investment still existed, it was as good as "hahas in the bank" until it wasn't. If Cheerful could have predicted that crash, he would have 1.2 hahas plus interest more than he does now.

    Unless Cheerful's predictive abilities in terms of housing futures vis a vis stock market futures are dramatically superior, equivalent risk exists today.

    As pointed out by X and Randy, your hahas are not in the bank until they are.

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