Study indicates house prices will drop
House Prices to Drop, predicts Fortune Magazine
In the November 7th issue, Fortune Magazine predicts that in most US cities, house prices will drop over the next five years. For Seattle, they predict that the value of an upscale house (one that sells for $854,000, double the median price) will drop 19.5% during this period.
How did they come up with this unsettling prediction?
If you have ever heard that values eventually “return to the mean,” you will understand their rationale. Fortune developed a particular methodology and their calculations show that big declines will be needed to bring house prices back to their historical relationship with rents. They base this on the fact that the ratios of upscale house prices to annual rent is well above the 15 year average. For Seattle the ratio is currently 38 to 1 vs. the 15 year average of 23 to 1. Fortune makes these predictions on the basis that people typically won’t spend more in monthly costs to own a home than they would to rent it. This drop would be even greater, except that they predict that rents will increase to partially offset this value disparity.
While no one knows the rate at which this adjustment might occur, owners who expect to need to sell their homes during this period would benefit by getting ahead of this projected price adjustment, to maximize their gain or minimize their loss. For example, the cited “upscale” house would lose $167,000 in value during the 5-year period, bringing a sale price of $687,000 in 5 years, according to Fortune.
Since it is known that houses will sell much more rapidly if priced at or just below the market, a savvy seller would put their house on the market at $787k (about 9% under current “value”) and rapidly sell the house. This would gross $100,000 more on the sale than they would get by waiting until the end of the five-year period.
The timing becomes even more acute if the owner needs to relocate and decides to rent the house and wait out the adjustment. Since current rents will not recover mortgage and other costs, the losses will compound. Here we have extrapolated the Fortune methodology to illustrate the dilemma of trying to rent out such a house during a downturn in the housing market:
• Making payments on a $450,000 mortgage, paying taxes, insurance and maintenance costs and charging a rent of 1/38 the value per year, or $23,361/year, results in a cash flow loss of $17,569 per year.This, added to the loss in value of the house, and the cost of lost opportunity for reinvesting the equity at a 5% return, results in total losses the first year of $70,141. Total yearly losses continue, although reduced to $51,100 the 5th year. Then, selling at Fortune’s predicted price of $687,000 results in net proceeds of $162,989, representing a net change (loss) of $175,253 as a result of waiting for the market to “shake out”.
• A savvy seller would get ahead of the curve and price the house for $780,000, which would probably result in a rapid sale and net proceeds of $269,940, or a “gain” of almost $107,000 over the strategy of waiting. In effect, each year of renting and waiting for the market to return, would cost over $60,000 on average.
• For an unoccupied house, some experts estimate that the costs will be 1% of the value per month due to mortgage, maintenance, property taxes and utilities. These costs are in addition to the loss of value, and in the above example total losses could be over $135,000 for a twelve month period.
If you own property in the Seattle area and are interested in an analysis of your particular options, please contact me, Aleta M. Thompson, Keller Williams Realty at 206/261-1465.