Interesting article in today’s Wall Street Journal about housing prices — the idea that homes in some areas might be undervalued, as the pricing pendulum has swung too far.
The gist is this: If you’re familiar with historical housing prices, you know that, relative to income, home values have remained stable. As the Journal points out
For decades, price-to-income levels have moved in tandem, with a specific housing market’s prices rising or falling in line with local residents’ incomes. Many economists say that makes the price-to-income ratio a good gauge for determining whether housing is undervalued or overvalued for a given market.
Specifically, home prices have been about 2.9x the average local annual income. (I.e., if the average household income in a neighborhood is $75,000, the average home will be worth about $217,000.)
Right now, in many areas, home prices are still above that 2.9 factor — that’s why some economists say we haven’t hit bottom. In Virginia Beach, for example, prices are still 47% above their historic price-to-income ratio; Richmond is about 42% above. (The U.S. as a whole is about 14% above.)
In contrast, some areas — notably Detroit and Las Vegas — have seen housing prices fall to well below historical price-to-income levels, meaning (at least in theory, this being economics) that they’re well undervalued. And people are beginning to take advantage.
“Values dropped so far that there are just great bargains,” said Dan Elsea, president of brokerage services for Real Estate One in the Detroit area. For years, layoffs in the automobile sector contributed to a “total freeze on activity,” he said. But over the past six months, as the industry has recovered, “you have this dam burst of people saying, ‘We’re ready to buy.'”
Many of those buyers, the article says, are people looking to rent the property — with a booming rental market, they’re finding a tidy profit awaits.
You might think, “Eventually the pendulum will swing back. That’s how these things work.” And you might be right. But Zillow’s chief economist, Stan Humphries, isn’t so sure:
Prices could keep falling in “undervalued” markets that are struggling with an oversupply of foreclosures or where high unemployment limits the pool of potential home buyers. “There’s no iron law that says a market will return to its historical average,” said Mr. Humphries.