By Harvey Sax
I was having a discussion with a hedge fund manager friend of mine about what determines house values and it dawned on me, this is really a complex question. Having been a stock trader for so long, I was quick to jump to the conclusion that a house is worth what someone would be willing to pay for it in a reasonable period of time. I'm not sure what reasonable means but perhaps a sixty to ninety day auction process would determine the real value. Of course there are the various real estate appraisal methods of valuation but that doesn't really interest me. Instead what creates the value?
There is replacement cost value. How much it costs to replicate your house for example if you were fortunate enough for it to burn down and be fully insured. I don't know how you would measure replacement cost any other way since in many areas of the country you can buy used houses far below the replacement cost of your own.
Assuming everything new costs more than something old;ie new shoes, new car, new bike all cost more than their depreciated equivalents. A new house should cost more than an old house. Then there is no impetus to build new houses until you can sell them for more than used ones or more importantly someone is willing to pay more for a new one than a used one.
Supply demand theory then comes into play. If you can buy cheaper than you can build, then no one builds. Unless you can't buy exactly what you want to build. So in part it's an emotional decision and not necessarily an economic decision. No wonder that the woman in the household plays such a critical role in the housing purchase decision.
Is it a necessity buy? You have to have some place to live, right? So is this an economic decision- buy versus rent? Or is it a quality of life and again an emotional decision? If that's the case the general economy has a huge role in the purchase decision. When economic times are good, people feel better about trading up.
Since you can always rent out a house for some price, there is a revenue stream associated with a house. You could apply a commonly recognized discounted cash flow analysis and come up with some value.
Government policy may be a determining factor. You may have to factor in tax savings into that equation as owning a house is a very significant taxable income deduction.
But that begets an even bigger economic question, what's the definition of good times? Inflation eats away at purchasing power but probably is one of the biggest factors in house appreciation.
Ugh, I don't seem to be getting anywhere in this analysis. No wonder I'm sticking to stocks. At least I can sell it tomorrow if I can't tell what it's worth.
Recommended reading: Bubble Meter blog
This was a timely chart by Robert Shiller presaging the house price collapse in 2006
By Harvey Sax