Sunday, April 02, 2006

I Hate to Keep Harping on Housing, But......

Saturday's NY Times article just reeks of the tech meltdown circa Jan 2000. If I had a dime for every business plan I saw the computed a valuation in some new way, I'd have tens of dollars :)

Basically two economics professors have put forth the theory that housing is not overvalued if the home would rent for a price inline with the monthly cost of ownership. This alone is not a scandalous theory, but it shows the professors are thinking in a vacuum. Their math assumes that rents are stable to rising. In 1991, just as real estate was bottoming in the tri-state area, rental rates at premier high rises were off 50% or more from their peaks. If a fixed part of your equation (rental rates) becomes a variable, your equation becomes g-a-r-b-a-g-e.

"In a paper the two presented at the Brookings Institution this week, "Bubble, Bubble, Where's the Housing Bubble?" they said that even though prices had risen rapidly and some buyers unrealistically expected the trend to continue, "the bubble is not, in fact, a bubble in most of these areas."

They argued that the value of a home is determined by the rent it could fetch. Calculate the future rents, subtract mortgage payments, taxes and other costs, factor in a good annual rate of return of 6 percent or more, and one should be looking at the proper price of a house or condo."

I had one final thought on housing tonight - Ask a CFO if he builds a factory or a new corporate headquarters what type of return he'll expect to show on that physical asset. Once she has stopped laughing you will probably hear something along the lines of "Well, of course we don't expect to show a return on the asset itself. Physical plant is a depreciating asset - meaning it's value should and will decline over time." I know it is different for housing an 80 yr house will be worth more than it was when it was built, but the question is should it be worth more?

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