Blog

Home Prices Relative to Peak Prices During Bubble

Home prices are off anywhere from 10% to more than 60% in cities across the country. There is no reason to believe that prices were "fair" during the bubble as we have seen they were largely caused by loose and aggressive lending by banks and non-banks. But, it is always better to buy at a discount rather than at a historical peak, and these seem like awfully big discounts. And by my calculations, in most cities across the country, real prices adjusted for inflation have just about come into line with where prices were in 1997, before all this crazy bank lending started, so there should be little additional downside risk by buying today. There are still some neighborhoods across the country that have not seen very dramatic declines in price, many of them very wealthy and expensive enclaves, but given the distribution of incomes lately heavily weighed toward the wealthy, these areas may never see a really large home price decline.

Home Prices Relative to Construction Costs or Replacement Costs

Homes in many cities across the country are now selling for as little as $60 to $70 a square foot. Depending on the quality of construction and the underlying land value, this represents a 50% to 65% discount to the costs you would incur if you tried to build a similar home today in these cities. While there is no guarantee that there will be a strong rental market in the short run, in the long run it just seems to make sense to buy if you can acquire assets at half or less of the cost of building them.

Home Prices Relative to Incomes and Rents

During the peak years of the housing bubble, entire cities like San Diego were seeing their homes priced on average at 11 times the area's median family income. Such prices financed primarily with debt are by definition unsustainable. Now, because banks have pulled back on their lending formulas, homes in many cities are changing hands at three to four times average family incomes. Similarly, at the peak, houses traded at such large multiples of possible rents that it made the projects uneconomic from the start. Now, with homes trading at more reasonable multiples of rents, houses and condos can be purchased that are immediately cash flow positive in year one and enjoy all the upside of any appreciation that will occur as inflation returns.