3 Simple Ways To Identify An Overpriced Market

By on April 25, 2015

Many people have had the experience of observing the steady appreciation of real estate values over time. And if a consistent increase of home prices exist, surely there must also be a steady decline of it? It just like the metaphor that if evil exist, the good must exist as well. If not, then there is no evil.

The irony is that everywhere that is worth investing, real estate seems to be in a period of appreciation. Things cannot go up in value forever. There must be a ceiling somewhere when the market wakes up. The only form of market correct cannot be a crash correct?

Most people do not have access to raw data to draw their own conclusions on where the market is heading. And even lesser people have insider knowledge of what industry big players are planning up their sleeves. So how can you tell that a market is overpriced and is due for correction?

1) Compare prices and rentals

Even as more and more people perceive properties more as investment vehicles rather than a home to live in, don’t forget the big picture of things. Because the mass majority of home owners and tenants consider a home as exactly what it is, literally. It is a home.

Under normal circumstances, the increase in home prices should be at a rate comparable to rental rates. When real estate prices increase, investors need a larger capital outlay. That investment will come back as higher rentals. A high demand from tenants for rental apartments make buying at higher prices justified for investors. It wouldn’t make sense if an investor forecast rentals to cover half his mortgage payments. That would look more like a gambler’s move.

So when home prices are going through the roof while rentals are stagnant, something is obviously wrong somewhere. On the surface, it will definitely look like prices are driven by speculation rather than real market demand. Deeper analysis might reveal weird methods on how properties are being valued.

2) Compare prices and income

Just like comparing against rentals, property price increases must be followed closely by income increases. It really does not make sense if property prices have risen 50% over 5 years while personal income of the general public have only risen 10% in the same period. Where is the money coming from?

When you make a higher income, you will be more willing to pay a premium rental to get the units you want. That will lead to higher property prices as investors can work out the returns comparatively.

So when income and rentals are not moving and home prices are constantly picking up, something unnatural could be causing the appreciations. Again, the number one suspect is speculation.

Speculators can win in the short term. But over the long term, the market always wins. If you want to see some evidence, just read up on the dot com bubble and subprime crisis.

3) Read independent reports

There are so many stakeholders in the real estate market these days that you can no longer know whether news have no underlying agenda. For all you know, the media that keeps reporting on how well real estate is doing could be owned by stakeholders who want to see prices inflate. And the articles your read on glamorously desirable condominiums could be advertisements disguised as editorials.

The best places you should do your research on are those that do not have a stake in real estate. For example, foreign property publications whose business is to publish research reports. When they have no direct stake in whether a market goes up or down, they are more likely to report unbiased news and opinion.

So when is real estate fair value?

Just because an appraiser determines that a house is worth a particular amount of money does not mean that that is final. Properties transact and above and below valuations all the time. The only way a fair value can be reached is when a buyer and seller agrees on a price.

Meaning if you feel that a house is overpriced, the only way that the market can recognize that is if you refuse to buy. Or only agree to buy at a low price. If not, you are just another player who is churning up the prices for everyone else. But bare in mind, the market always wins over the long term.



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