Have you ever asked yourself, “Are home prices over- or undervalued today?” If so, you have been comparing current prices to prices over the long-term trend, which is known as intrinsic value.
Many of the best investors in the world tout intrinsic value as the most important metric for long-term investing. Buy when prices fall below intrinsic value and don’t buy when they rise above. The difficulties come in determining your opinion of intrinsic value and having the patience and courage to withstand what can sometimes be very long periods when prices are over- or undervalued.
Last week, we sent our values to our clients, and just this week John presented the methodology at a mortgage industry conference in DC. The reception has been fantastic.
To cut to the chase, we believe a long-term view of housing dictates that homes are overvalued today by 3.5%—but range from 11% undervalued to 20% overvalued depending on the MSA. This is not a bearish view on housing simply because:
- 3.5% income growth will solve the problem
- We used a 6.0% mortgage rate for our calculation, and rates are much lower today
We also assumed that the best long-term ratio of housing costs / income* is 31.4%, ranging from 21.0% in Atlanta to 79.5% in San Francisco. In 29 of the top 30 markets, we used a ratio that is higher than the historical average over the last 20 years because we believe US housing has become slightly more expensive. Determining this ratio by market was difficult, particularly in markets that seem to be undergoing permanent changes in homeownership demand, both positively and negatively.
As you can tell, intrinsic value involves art and science. We aren’t sharing our conclusions by MSA because our clients pay for this insight, but we are sharing our national conclusions and the key components of our methodology to help you answer for yourself: Are home prices over- or undervalued today?
*The housing costs / income ratio is the percentage of income necessary for the median-income household to buy the median-priced home.
