My Personal Finance Journey

Personal finance observation, musing and decisions in a journey toward financial independence by 2020 with at least $3 million.

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Fortune: Home Price Faces 16% Correction In Five Years

Contributed by mm | November 13, 2007 4:18 PM PST

With the sudden realization that the housing boom is officially over, our interest is shifted to where the bottom is. To that end, Fortune Magazine released an in-depth analysis on how housing price in 54 major cities will likely evolve in the next five years. Fortune's analytical framework assumes that the ratio of rental cost and home price will return to a historic norm, and the journey to a normalized price/rent ratio will involve a correction of current home price, in conjunction with gradual rental increase over time.

The conclusion: on average, the nation's home price is over-valued by 28%, and for it to return to the norm in five years, we should expect 16% price correction, in addition to 12% increase in rental cost.

Here's how we reached that disturbing conclusion. We started with the median price of existing homes in 54 metropolitan areas, using numbers from the National Association of Realtors. We then compared those prices with the annual rent on similar properties - houses, condos, and apartments with the same number of square feet as the median-priced house in each market - using figures prepared by Property & Portfolio Research, a commercial real estate research firm. That gave us a price/rent ratio for each area. then compared the current P/R ratio with its average over the past 15 years and calculated how much it would have to decline to return to its historical norm. The average drop for all the markets we surveyed is 28%.

But that's not the whole story. The adjustment doesn't come exclusively from a fall in prices - rising rents also help close the gap. To complete the picture, assembled a forecast of rental growth in each market; the average rise in our 54 markets is a total of 12% over the next five years. So to reach the average correction of 28%, prices need to drop only about 16%.

If you are interested, Fortune provides tabulated breakout by major metropolitan areas. If the prediction is right, residential properties in Orlando, Miami, Tampa, Baltimore, Fort Lauderdale, Las Vegas, Sacramento and Washington DC are all facing at least 25% price reduction in the next five years.

So how about my second home Seattle's prospect? Fortune says it will take a 19.5% price reduction, and 19.2% rental increase, for housing market in Seattle to return the price/rent ratio to the 15-year average of 23.3 in five years.

Those of you who followed this journey for at least two years knew I sold my house two years ago on FSBO basis for $420,000, a tad early to miss the tail of the housing boom. Today, several identical houses in my previous neighborhood are listed at $490,000 but without a real sale for months. On an after-commission basis, these listing prices are about $465,000, or 10% higher than what I got two years ago.

Apparently I'm much better off with the selling decision two years ago. My portfolio returned over 32% in the last two years, so my proceeds of $420,000 in October 2005 is already worth over $550,000, a handsome advantage over the $465,000 my ex-neighbors are counting on today. Plus, more likely than not they need to slash the price even more to land a sale. And if Fortune's crystal ball is adequately good, they probably won't even fetch as much as I got in 2005 if prices need to be marked down by another 19.5% to be appropriately valued.

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This Post Has Received 12 Comments. Share Your Opinions Too.

Ear Commented on November 13, 2007

I never get these lists... According to it (unless I'm reading it wrong), 349K in June 2007 buys you an upscale home (double median price) in metro Atlanta... Different Atlanta? For 349K you get a fixer upper in need of a lot of love. If you look hard, you can find a nice 2 bedroom, 1 bath for that but it certainly isn't upscale.

ted Commented on November 13, 2007

That's a bit depressing especially for people facing forclosure or those teetering on the edge - we in CA. paid way too much for our ugly tract-homes.

Deborah Commented on November 13, 2007

Very good on the home sale...

I am in the process of selling my home for similar reasons... I hope I'm catching a top...

Interesting, when we bought 4 years ago we had about 1/3rd down, yet with selling and what we've paid down on the mortgage we will bank about 3/4rds...

john Commented on November 14, 2007

Predicting the future in real estate is simply voodoo magic mixed with future telling. Maybe Fortune mag can tell me the tommorrow's winning lotto numbers. Pure speculation and not worth the paper it's printed on.

Graham Lutz, The Young Capitalist Commented on November 14, 2007

This is a great thing for my wife and I as we are saving to buy a house, planning a purchase is in 2011 or 2012!

juan22 Commented on November 14, 2007

Congrats! It is definitely a buyers market now.

Mike Commented on November 15, 2007

Ear: You must be talking about Virginia Highlands or Buckhead. That's not "average" Atlanta. They're talking about the entire metro area, all the way up to Cumming and down to Peachtree City.

Ear Commented on November 15, 2007

Mike, yeah, Candler Park. Friend lives in Cumming. House cost half of mine yet has 3 times the space. And mine was a fixer upper. :) His basement is begger than my whole house. Crazy. Just never could live there, like the city life. Probably have to sell soon and it's a horrible market to do so right now. Hoping everyone is right that says selling intown is always easier since there are always people looking to be closer to work.

Joe Banks Commented on November 16, 2007

So if I am looking to buy a house right now at say $435K should I wait or buy now? Here's the sticker - I'm paying $2000 a month in rent. If I buy now, I stand to lose about $69k in equity over the next 5 years but if wait I throw away about $120k in rent. What is the conventional wisdom on that?

Roald Commented on November 17, 2007

Joe Banks:

You need to factor in how much other money you'd be "throwing away" if you buy. Taxes, insurance, association fees? What if something breaks? Your problem. Also if you look up a 30 year loan and see how the payments break down, you'll see that roughly 90% of what you pay for the first 5 years is interest. I don't know your particular situation but all things considered, renting is very often the best choice for most people right now.

pfodyssey Commented on November 19, 2007

The recent decline in home sales has put our own plans on hold (we already own the lot, so no hurry to get the house on it). However, we live in a part of the country that didn't see the spectacular run ups on the coasts and so are still waiting for the bottom to fall out (or at least sag a little?). No doubt, there isn't much construction going up...but sellers are still trying to toe the line as far as prices...I bet they blink before I do though.

Sadly, this whole debacle is yet another example of how many people will hang themselves financially if you only give them a little rope. Up next: credit card delinquencies.

JD Commented on November 23, 2007

To Deborah:

Sorry but there is no way you are catching the top. The top would have been early-mid last year. Right now you're actually selling in the worst type of market. Not only have prices come down but fear is ruling everything. A year from now prices will still probably be softer but people MAY have become comfortable with the market and set realistic expectations. Right now anyone who is buying is driven by the constant headline news of the housing market disaster so they are being cautious as hell and looking for very low prices. My uncle had his house on the market since February and had to sell because he was taking an overseas assignment. He ended up finally selling in September. He initially listed it at $840K which is what the comparable homes in the area were "valued" at. He ended up having to sell for $680K - about a 20% drop. And this was in Northern NJ, a market that has been relatively resilient.

Put another way - this is not a good time to be a home seller.

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