What if housing is undervalued and the market is just playing catch up.

Discussion in 'Economics' started by The Kin, Jul 5, 2005.

  1. New Theory

    What if housing is undervalued and the market is just playing catch up, and low interest rates have simply increased the velocity of this catch up except in the case of interst-only mortgages.

    Unlike income producing real estate, the value of a residence is not a function of future cash flows. Income producing real estate on the other hand seems to be reasonably priced. It's only residential properties which are seeing this double digit price appreciation in real estate.

    There is no new land being created. New supply is nil while demand for this limited supply of land continues to rise.

    Real estate is also relativly illiquid and demand can significatly be increased or decreased depending on interest rates. The use of Interest Only mortgages combined with very low rates have caused prices to rise faster than they would have if traditional mortgages were only available. Only those markets which rely deeply on interest only financing may be the ones truly in a bubble. (California, Costal Florida?)
    With a I/O mortgage, 100% of the monthly payment is tax deductible at the marginal rate.

    For all this to be true, when long-term interest rates start to rise we should see a decrease in price appreciation or for prices to stagnate. But we should not see price depreciation on a large scale except in those markets which rely heavily on interest only financing. What happens in those markerts will be anyone's guess.

    When rates start to rise, potential buyers will opt to rent instead, driving up rents but keeping price appreciation to a minimum. When the fed finishes its tightening and begins to lower rates, we will once again see prices take off as the buyer has access to more dollars. Strong demand will return but supply will still be the same as it is today. Prices will have to catch up to make up for the years it had zero to minimal appreciation as the demand has since increased but supply remains the same.

    It will also once again becomes cheaper to purchase than rent. It still is cheaper to purchase than rent in some markets which leads me to believe housing may be still undervalued in those markets. (i.e. Omaha, Jacksonville is still cheaper to purchase than rent.)

    Just bored so I wrote this little rant :p
  2. I'm gonna still opt for the lax lending standards hypothesis. Of course, there are other factors, but I think this one has the most relevance.
  3. "When rates start to rise, potential buyers will opt to rent instead, driving up rents but keeping price appreciation to a minimum."

    Hi Kin,

    I think we agree that some, mostly big city and coastal, RE markets are expensive relative to the personal income of these areas. The flaw I see in your argument is that rising rates will cause buyers to rent instead which will keep rents up. These people are already renting.

    Measuring overvalued relative to past history will tell us nothing about when a bubble will pop. It is entirely psychological. I would just say that the current US RE market is displaying bubble like tendencies. Beyond that, your guess is as good as mine.

    PS I sold a vacation home in MI. with a 60% profit. Bought '99-sold '04 when I left the country. I will be coming back in 6 months and renting and praying that this bubble pops in the next three years. On the plus side rents in Chicago topped in 2000.
  4. empee


    haha,, this is the exact reasoning I used for the internet bubble 'cause I couldn't understand it. I figured that global liquidity opening of our markets to international money flows and ease of electronic trading allowed many more people to invest, thus the new average p/e was going to be 50 or whatever.. of course, we know how that all turned out!
  5. The value of a residence is the present value of rent you would pay for it. In real world, a single family house is hard to figure out the equivalent rental rate though, but in theory cash flow method is still the way to value it.
  6. wow, cool of you to disclose that thought process.
    it's good to question the assumptions, as long as you have your stops in.
  7. ===========
    And another thought process could be in market.

    What if homebuilders and oil/gas sector do become fairly valued;
    and keep trending up with those P/E ratios go past 50 area , because William O'Neil /Investors Business Daily and many others dont use P/E for main measuring way.

    ''How it all turns out'' may depend on your stop loss also;
    and you may look at far more charts/prices than me,
    most of my markets resemble mountains /valleys.

    However with insane leverage , some have popped out like bubble;
    good warning Empee.

    Be diligent [careful] Solomon,trader king.
  8. gnome


    With construction costs $100/sq ft and finished product $300+ /sq ft.... looks like bubble territory to me.
  9. at some point earning power will be a countervailing force -- real earning power, after *borrowing power* becomes too expensive.
  10. I see your reasoning. But there are other factors to consider such as utility from owning your dream home. Also making a mortgage payment is better than making a rental payment since you build equity in the home and will one day be mortgage free.
    #10     Jul 6, 2005