The best predictors of the long-term value of a parcel of real property are the following two ratios: (1) the price-to-rents ratio; and (2) the price-to-income ratio. The price-to-rents ratio is the direct comparison of (1) the price of the property; and (2) the amount in rent that the property can yield over the next twelve months. The price-to-income ratio is a direct comparison of (1) the price of the property; and (2) the average income earned by people who live in the area where the property is located. These ratios provide a reliable assessment of the likely long-term price or value of any given parcel of property.
Other significant considerations are as follows: (1) Population trends in the area; (2) the long-term economic prospects of the area; (3) the available inventory of new and used properties for sale in the area; (4) the availability and cost of mortgage financing (“cost” refers to interest rates for mortgages); and (5) the appraised value of comparable, nearby properties.
According to the Economist magazine, residential and commercial properties in most markets across the United States appear to be reasonably priced as of January, 2014. The prices look sound — neither too high nor too low. Specifically, the price-to-rents ratios in most US markets suggest that home prices in the US are 5% overvalued, while the price-to-income ratio suggests that home prices are 10% undervalued in these markets. The Economist therefore has concluded that as of January, 2014 real estate in the US looks reasonably priced. These same ratios showed that real estate was fantastically overpriced during the great bubble that crashed in 2007-08.
William Markham ©.