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How low will housing prices go? Reasonably establishing the bottom of the market.

By
Real Estate Agent with Keller Williams Preferred Realty

I'm frequently asked, "Are we at the bottom yet?" (I don't know) - or - "Will we ever recover?" (Yes.  At some point.)  These are questions important to my clients.

And here is our first problem:  we can only talk about the top or bottom of a market in HINDSIGHT.  Does that make sense?  We can't reasonably know if we're at the bottom right now - tomorrow may prove us wrong.

In the absence of knowing if we're at the bottom, it would help to have some perspective on housing prices and the dynamics of today's market. 

We cannot generalize across the entire housing market.  Sorry.  $200,000 homes play by different rules than $1,000,000 homes.  As nice as it would be to make wide-sweeping rules - it simply doesn't work.  Ever tried getting a market value off an algorithm-based site like Zillow?  Accurate, huh?

What establishes the lowest fair market price of a house?  In my experience, the answer is rent.  That's right, the potential rent for a property can be used to establish value.  So the question isn't "what establishes the value", but "who establishes the value".  And that who is an Investor.

In this market, investors buy houses when they become a good deal.  Typically more complex than wanting a "good deal", investors choose to buy a property when the return-on-investment is right for them.  It makes sense when you think about it - what could be a more objective pricing strategy than the potential income? 

So the question has now changed from "what is the lowest market value of a home?" to "What is the highest price that an investor would be willing to pay?"  Voila!  That's the number we're interested in.  Because if the price of a house dips below that investor-set threshold, it will most certainly be purchased.

My rule for the past 2 years is called the 1% rule.  Whatever you pay for a home, you should get 1% of the purchase price each month in rent.  So for a $120,000 home, I'd expect at least $1,200.mo.  Put another way, if you're looking at a property to buy and it could rent for $1500/mo, what is a great price to pay?  $150,000.  Of course there are exceptions - lots of them in fact - remember, no wide generalizations.

This scheme works for the bottom of the market (forgive me, "starter" homes).  These rules do not apply to higher end homes.  What establishes the value of these properties is quite neurotic and will be discussed in another post.

Thanks for reading,

Robert

 

 

 

Comments (2)

Stanley Stepak
Howard Hanna - Avon Lake, OH - Avon Lake, OH
Realtor - Avon Lake, Avon, Bay Village, Westlake,

I have used the 1% rule myself and felt it was safe bet for costs that may arise.  I don't know if we have hit bottom but my feeling is that we are close and that a swing should happen in next 2 years

Sep 06, 2010 02:52 PM
Robert Stewart
Keller Williams Preferred Realty - Lakeville, MN

Good point - and because that lowest market value tracks with rent - you can quickly begin to see the role that the unemployment rate plays.  I'm still working on that one.

Sep 06, 2010 02:59 PM