Fundamental Values

Price/Rent Ratio

We've discussed trends in median prices and Case-Shiller as well as IHS Global Insight's view that Las Vegas is the most undervalued large metro area but fundamentally, where are Las Vegas home prices? While fundamental values are unobservable, we can use proxy indicators such as the price-to-rent ratio. One can think of this like a price/dividend ratio in stocks.

As the exhibit below demonstrates, the recent price/rent ratio is far below the baseline, which we've established based on the 2001-2002 years before the ridiculous run-up in prices. We have experienced severe declines in prices, driving the ratio down. The mechanism of the market can bring this ratio back into line by a combination of rent and price adjustments, which we are seeing now. Rents appear to be declining due to the amount of available inventory as well as weak employment and diminished household formation. However, rental prices have been quite sticky. Home prices have not been sticky and we saw massive adjustments.

Currently we have been settling and have observed median prices bounce between positive and negative on a month-to-month basis. Based on the price/rent measure, it is reasonable to expect that when employment rebounds and in-migration resumes with force, we will again see home price appreciation and a return to fundamental values. When could this happen? Thats difficult to say. When prices were above our measures of fundamental values it was pretty easy to make a forecast. For a monthly forecast, as long as it was in the single digits and had a negative in front of it, that was a reasonable forecast. Now that prices are undervalued but you still have underlying economic weakness, its difficult to forecast. Monthly forecasts have not been what our investors are looking for however. A typical strategy (not by flippers of course) is to hold with the expectation that you will own it for at least five years. What do you think will happen in five years? Ask yourself that, frame it in the context of your risk tolerances and carry costs and take a look at some of the residential assets in the market today. It might be very worthwile.

For a slightly academic discussion of price-rent ratios Click Here.


             Source: Mlxchange, Coldwell Banker Premier Realty.