The 'PE Ratio' for O.C. Homes—The Sky Is Not Falling!

The Shilling Group came out with a prediction that housing prices will fall another 20 percent nationwide. I am sure you have heard about it. Every water cooler expert will advise you that they know for sure. Do they really?

In 2005, (just before the peak,) the OC Register came out with an article that said that by 2010 the average price of a home in South O..C would be $1.4 million. What’s up with that? 

The author claimed that the demand was so much greater than the supply, there was no choice. We know that sensationalism attracts attention and sells products. Just as the over-enthusiasm to positive predictions is unrealistic, so is the over-reaction to negative news. Of course, we all know that jobs are a key. The private sector is the only source of real jobs.

Have you ever thought that just as stocks have a PE Ratio (Price to Earnings) so do houses?  At certain levels of low PE the stock market makes sense because you are making a return greater than the cost of the stocks, even if the price does not go up. At a lower PE it becomes a real buy.

What is the PE Ratio of housing? (This is not original to me, by the way.) Look at it this way – investors typically put 20 percent to 25 percent down to get an investor loan. If the PITI is at or lower than the current rental rates then the investor is in the black. In our area investors are taking money out of the stock market and buying investment homes.  

For example - purchase a home for $550K with 25 percent down. The loan is $412,500 (conforming) and at 4.5 percent, which makes the PITI (monthly payment, which includes Principle, Interest, Taxes and Insurance) $2,090. With a $110 HOA the total monthly cost is $2,200. In Laguna Niguel today it is very difficult to find a detached home for rent at $2,200. Usually you will pay $2,300 to $2,700 a month for a three-bedroom, per month. Does the Price to Earnings ratio make sense?  Investors are saying, “YES!”  Homes are selling and there seems to be a floor developing in the lower price ranges.

So, what does all this mean? At today’s prices it once again makes sense for first-time buyers and it makes great sense for investors. In our example, the investor makes between 2 percent and 3 percent, not counting the investment depreciation on tax day. If you hold until prices go up some you will seem like a genius. Don’t forget where we live!