by John Raines

Created on: May 01, 2009

Now that the irrationally exuberant real estate market has deflated, real estate values are returning to more normal levels. Although with prices collapsing in some regional markets, many people question the very concept of normal value. But, the fact is, you need a place to live, you need a place to work and you need a place to play. These basic needs provide the foundation on which real estate value rests.

If you need someplace to live, the choices are either buy or rent (assuming you are beyond living with Mom). If you decide to buy something, the choices are an existing home or a new home. Those three choices; rent, buy something new or something that exists intertwine to establish the basic value of homes.

Real estate is a classic example of how markets function as buyers and sellers act in their self-interests. The average person has some part of their income they are willing to pay for a place to live. What they will pay could be used for rent or to buy a home. So, rents and home values compete in the marketplace. Likewise, many people will not pay more for an older home if they can buy an equivalent new house. Conversely, the prices of older homes tend to hold prices of new homes down. So, all the values are linked in this competing marketplace and are driven by personal income.

The home mortgage crisis dramatically demonstrates how home values and household income are related. Starting in 1987, home values and household income increased in almost perfect unison to about 1999. In late 1998, home prices began to increase and soon outpaced income growth by double digits. This rapid price growth was fed by mortgage lending that essentially ignored risk. When the loan crises started in 2006, the mortgage money vanished and home values began to tumble. At the current rate, home prices should level off near household income in early 2010 although values will not stabilize completely until inventories are worked off.

There were a couple of things driving this bubble in real estate. The huge amounts of money flowing into mortgage funds fed the easy financing that enabled the demand. There was also the wide held belief that property prices could keep increasing indefinitely. Many of the people in that real estate market had never seen any real decreases. This overconfidence helped created hyper-inflated markets, such as California and Florida, where speculation fueled double digit increases. These markets also were the first to fall.

During this market the demand

• 1
• 2
• Next Page >>