According to your formula, the point where selling price = capitalized value represents some level of cashflow yield over time, which is the right way to approach this. But a couple of questions:
Why settle on a period of 8-10 years?
Also, try running this calculation using a property where you know approximate rental income and asking price. What I think you will find is that selling prices need to fall a long, long way before your model shows them as attractive.
I rent a 3BR in Carmel Valley and according to your model, the price of similar units on the market nearby will have to fall by 40-50% before they make sense on a cashflow basis!
I agree with your calculation for your Carmel Valley home. The home that I rent is ‘worth’ ~$1.2MM (a smaller, unimproved home across the street sold for $1.4MM in January). Based on 8-10X, my rental home is worth $250-325K, necessitating a 70-80% drop.
I discussed this very same topic with my wife this weekend, and made the following observation: median prices for resale homes in La Jolla today are $1.7MM; in November 1994, La Jolla’s trough, they were at $395K. Our home is worth ~75% of today’s median; in ’94, 75% of the median was ~$300K.
Is it possible for prices to revert to ’94 levels? Hard to believe it’s possible. But, it all depends on whether you think we’ll have a simple recession, or a full out depression.
If you think we’ll have a depression, and I think we will, all bets are off: e.g., the price for General Motors stock peaked in ’29 and fell to a trough of 15% of peak in ’32. And, GM stock still had NOT regained its ’29 peak price by ’48.
Big bubbles (the ’29 burst was of a big bubble, first in real estate, then in stocks) take a long time to work through, and the process, from what I read, appears to be painful.
Yeah, that kind of scenario envisions HUGE job losses and as you say, would be a lot worse than a simple recession.
I try to look at what kinds of price levels will get cashflow-oriented investors back into the market here.
If I assume current rent levels, and interest rates around these levels, then I think a 25-30% correction from current levels would really get professional investors interested.
And that would get us back to equilibrium quickly.
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