• Bridget Sullivan Mermel CFP(R) CPA

How to Think about Real Estate Prices


I'm not very interested in predictions about how long the current economic downturn is going to

last. What I'm interested is in the thinking behind the predictions. Here's what I think about the segment that started the downturn:

real estate.


My basic formula is that we'll see the bottom when

foreclosures have brought prices down enough so that it costs

as much to own as it does to rent. That sweet spot gives

investors the incentive to buy rental property.


The first caveat is that, in a particular area, if there is a

lot of property in foreclosure, the prices can fall below the

formula. The banks that own the foreclosed property might

just want to unload it, driving prices lower and lower.

However, if the foreclosures run through the system in a

fairly orderly fashion, the prices will go down until it's a

good time for landlords to buy property. Similarly, in some

areas that are very desirable right now or have very little

rental property, the prices may stay higher than the formula.


The second caveat: this formula works if there are no big bad

unexpected events. Big bad events usually include a lot of

people dying, losing their jobs, or losing a lot of property.

GM going bankrupt was big and bad but not unexpected; people

knew that it might happen. The events that could affect the

recovery are events, like natural disasters, that are a

surprise.


With formula and caveats in mind, let's look at Chicago.

Readers in other real estate markets can follow the logic and

apply it to their own. In Chicago, we don't have some of the

factors that make the housing crisis so severe in other parts

of the country. We aren't suffering huge population loss

because of industry moves, like in Michigan. Also, people

don't tend to buy second homes, which have a higher risk of

abandonment and foreclosure than principal residences, in

Chicago. That's Florida and Las Vegas.


But the real estate market isn't a monolith here. The types

of buildings matter a lot right now. A recent story in the

Chicago Tribune details how Chicago two-flats (two story

buildings where you live on one floor and rent out the other)

have come down in price. According to the Trib, now it's

worth it to buy with the intent to rent:

http://www.chicagotribune.com/classified/realestate/advice/chi-0628-two-flatsjun28,0,7127635.story


I wasn't sure if I believed it until a friend called and told

me about a two-flat she has her eye on. She's planning on

living upstairs and renting out the first floor. Financially,

it sounded like a great deal. So, using my formula, pricing

for two-flats could be at their low.


Condos are still facing problems right now, especially new

construction. It's more difficult to get mortgages on condos

than it used to be. Lenders are more skittish about condo

associations and have tightened their standards considerably.

This American Life ran an episode with one Chicago condo

horror story.

http://www.thisamericanlife.org/Radio_Episode.aspx?episode=377


So, using my formula and caveats, it may take a while for the

condo market to get back to normal. The issue isn't price,

however, as much as availability of mortgages.


On the single-family home front, I was talking to my local

building inspector a few weeks ago in the near-western

suburbs. According to him, there are a lot of properties in

foreclosure in my suburb and even more in pre-foreclosure.

The foreclosure situation is worse than in many parts of the

metro area. This sounded like bad news. But when he told me

about a how much a neighbor of ours is renting his house for,

I did the math in my head. A light went off. Ah! The

magic formula was approaching. What the neighbor could rent

it for and the market price are coming together. If nothing

catastrophic happens, once the foreclosures move through the

system, things will probably turn around in this segment of

the market, too.


Does this mean I am suggesting you buy now? No. Don't buy

because you suspect that the real estate market may be around

the bottom. Buy if now is a good time for you to buy for

other reasons. And buy with your eyes open. While the

economic news has settled down for the time being, we are

still financially vulnerable. We need a lot of good news

before the recovery is really on its way.


Does this mean that the housing market in other parts of the

country have hit bottom? I have no idea, but I'm interested

in your thoughts! Enter a comment and let me know what you think.

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Sullivan Mermel, Inc.

3744 N. Southport Unit G

Chicago, IL 60613

Ph. 773-404-9344
Fax: 773-327-1461

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