Watching the fundamentals – Where is the real estate market going?

When I sold my last investment property in 2005, something inside of me said it was the time to sell. (as for my timing, I got totally lucky) While I sold for the fact that I was averaging per unit only $120/mo and the appreciation over a 2 year period got up to 35-40% on properties…there was another factor that didn’t seem to make sense. That factor was a stat that I saw, a fundamental stat, how income levels were not rising at a similar rate to home prices(appreciation). Think about it…home prices are going up at a fast rate, yet incomes are staying relatively flat.

COMMENT – How did most people afford their homes from 1995-2005 without the same level of income increases…well that was in thanks to the availability of money, creative loan products, and the reduction of qualifications required to get a loan.

Recently I found this chart, which really highlights the point. Before I share, it is important to state that I am looking at the 50,000 foot view, specifically the US as a whole. Obviously different regions, county’s, etc are going to trend differently and at different time periods, and some will have ‘bigger’ ups and downs. Maricopa County (AZ), where I live, had one of the largest appreciations between 2003-2005 and has also had a huge decline as well. Maricopa is still considered a declining market today by lending standards.

Here is what I see:
While this chart is a 2007 chart, the numbers don’t lie. Historically, median incomes and median home prices have shared a close relationship. If you look at the chart you will find that the ratio of median housing value vs. median household income was normally between 2.6 and 3.0.If you want to take some averages, then median home prices were about 2.8x the median household income for the last 30 years. Using this 2.8 formula, it is very easy to estimate what median home prices should be today. The 2007 number for median household income comes out just over $50,000, which by using the formula would put us at close to a median home price of $150,000. Where is our national average at as of August 2008…$203,100. So what does this mean…Does this mean that I believe we still have an addition 25% median price drop? Who knows, your quess is probably as good as mine!! What I do know is that based on this fundamental trend, we are still a bit high. The factors that we cant predict… revolve around government policies and decisions. While these policies are possibly at affect from our presidential elections, if I had to guess, we probably aren’t at a bottom yet but I would be surprised if nationally it did drop the full 25%. For investors, this is another supporting stat that the opportunity to buy is nearing if not here already. Especially if you are buying properties at a discount based on today’s value and for cash flow purposes. In theory, if you are able to buy a home at 60-70% below today’s value, and the market does correct another 25% then you still have equity. Even more exciting, today’s market is showing signs of cash flow again. No matter what the market does, cash flow is the key to surviving this time as an investor. Based on who is leading the polls and the current economic turmoil, I am planning that I will hold properties 7-10 years for cash flow, or rolling profit into 1031 exchanges… especially if capital gains increase and appreciation is stable (5-7%), it will be some time till we see the ‘flipping for appreciation’ game again.Any Comments?

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