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Now, Is Housing Fairly Valued?

Here's a brief article that examines the thesis that housing is fairly valued now for San Diego, which plays into the timeframe for the national environment.

Japan's experience with their boom and bust sheds some light on our situation.  Real estate values went far over the overall inflation rate and then fell back down to the level that it would have been had real estate tracked the inflation rate.

Using that as an assumption for our analysis, let's figure the endpoint of housing.  While there can be an undershoot, and my feeling is that we have a decent risk of another leg down, this analysis still should give us some color where we stand at present.

Assuming inflation was 2.5% per year (average Cleveland Fed median and trimmed mean CPI), let's compare the levels of inflation to housing inflation, assuming the housing boom started in October 1998 and went for 7 years to October 2005. 

Regular inflation = 1.025 ^ 7 = 1.1887

Housing in San Diego median prices 604K / 207K = 2.9179

Housing must come down to the level of all other products as influenced by overall inflation.  If the correction were immediate, that would imply prices falling by 1.1887 / 2.9179 - 1 or a drop of 60%.  However, corrections are rarely immediate and regular inflation of other goods occurs during the correction period which diminishes the necessary correction, relatively speaking. 

Let's assume a 4 year correction period ending in late 2009 with a resurgence of inflation so that the average is at 2.5% again ...

Regular inflation puts housing at = 1.1887 x 1.025 ^ 4 = 1.3121

Final resting place for housing compared to the peak = 1.3121 / 2.9179 = 0.4497 or roughly a drop of 55%.  Keep in mind the longer the correction, provided inflation continues, the less housing has to fall.  So if it takes until 2012, which adds 3 years and the inflation rate remains at an average of 2.5%, the final ratio is 0.4842 or a drop of 52%.  With YOY drops near 20%, we should be nearing a slowing of the rate of decent and perhaps a flattening for a few years.

Since not all housing had the runup experience as did San Diego, this is a good estimate for that city, but it would have to be recalculated with more representative numbers for locations that have less "excess over inflation".

Bottom line: right now, housing is fairly valued.

If housing does have another leg down (say from fallout from commercial loan resets which will put stress on the banking system - or from the economic situation putting additional pressure on housing), it should soon prove to be a good buy.

Disclosure: Jim holds no positions in regards to this article.

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