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. Economy.com 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, Economy.com 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.