My approach to identifying when to buy will be as follows:
1. Use the Free Inflection Point Forecasting Model (FIPFM) to tell me the momentum of the market, i.e., whether prices will still be moving down or may soon be moving up.
The rental rates for 3 bedroom and 4 bedroom properties are for homes; I know of few (actually, no) apartments that are 3 or 4 bedrooms. I will be pulling down rental rates at the end of every month for San Diego as a whole and La Jolla, too.
3. Using the Rentslicer data, calculate the capitalized value:
Monthly rent x 12 (months) x 8 to 10 (years)
4. Compare the capitalized value to the actual median price for a resale home per the monthly DataQuick press release in the Union-Buffoon.
If the actual price > capitalized value, hold
If the actual price < capitalized value, consider buying, but only if the predicted price per the FIPFM is going up. If the predicted price per the FIPFM is going down, wait, because you may be able to get a better price later.
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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