Real estate pricing
Real estate pricing deals with the valuation (finance) and there are three main methods: appraisals with comparable properties, capitalization rate comparisons with similar income producing properties, and discounted present value of expected future cash flows.
After realty prices are estimated, recorded or otherwise reported, there remain two major ways in which aggregate home prices are reported: median and mean (average). Prices are also calculated by square foot, using both the mean and median price. Real estate prices have had a profound impact on urban, as well as the suburban and rural landscape. The most important government measurement of home prices in the United States is the house price index. Median house prices are reported for metro areas and regions of the country by the private National Association of Realtors.
Median home price
The median home price is the threshold which divides the real estate market into two equal halves, in reference to pricing. One half of all homes in the market were sold at a price above the median home price, while the other half were sold below that price. For example, the median home price in the United States was $213,900 in the fourth quarter of 2005, meaning that half of all homes sold in the US were priced above $213,900, and half were priced below $213,900. In California, the median home price was $548,000.
The median home price is one of the most common measurements used to compare real estate prices in different markets, areas, and periods. It is said to be less biased than the average since it is not as heavily influenced by the top 2% of homes sold. For example, the average home sale price in the US was $264,000 in October 2005, compared with a median home price of $213,900 for the same time period.
Mean (average) home price
The mean home price, or average home price is the sum of prices of all homes sold in a certain area in a certain period, divided by the number of properties sold in the same area in that period. For example, say in a hypothetical townhouse complex there were five townhouses sold in March 2006. The properties were priced as follows: one for $450,000, one for $459,000, two for $465,000, and one for $499,000. The sum of all of these properties is $2,338,000. This number is then divided by five, which equals $467,600. Thus, the mean home price for a townhouse in this complex was $467,600 in March 2006.
Per square foot pricing
In per square foot pricing, the total price or rent of a unit is divided by the area of the unit.
Sales price per square foot
Sometimes real estate prices are measured by the price of each square foot. This allows for a better comparison between differently priced homes as well as homes of different sizes. In this pricing measurement method, the median or mean price of a home is divided by its area. For example, a 1,243 sq ft (115.5 m2). home was for sale for $465,000. To find the per square foot price, the price of $465,000 is divided by the area of 1,243 sq ft (115.5 m2). The result, $374.09, is the price per square foot for this particular home.
To effectively compare neighborhoods, the mean or median home price of a neighborhood is divided by the mean or median area. To refer to our example of Villawood Townhomes in Salinas, CA, the sold units in Willowood range from 1,243 sq ft (115.5 m2). to 1,621 sq ft (150.6 m2). The first four units are each 1,243 sq ft.; the fifth unit is a little larger, measuring 1,621 sq ft (150.6 m2). The area of all units combined is 6,593 sq ft (612.5 m2). This number is divided by five, the number of homes for sale, and the result, 1,318 sq ft., is the mean area. The mean price for the sold townhouses in Villawood of $467,600 is then divided by the mean area of 1,318 sq ft.; the result is a mean price of $354.78 per square foot. This also includes the lot the home is built on (which varies in size).
In cities where condos, co-ops and to some extent townhomes and row houses are more prevalent, the prices do not include the land, since that is not owned by the indiviual but the entire association (though older town homes and row houses sometimes are not part of associations). The size of city lots are generally much smaller than those in the suburbs, measuring sometimes a mere 20 feet (6.1 m) wide for a 3 or 4 flat apartment building, with little to no land left for vegetation.
Rent per square foot
Rent is also calculated by square foot. The rent per square foot is often used as an effective tool in comparing units and different markets, when units are of different sizes. For example, in March 2006, a given 1,600 sq ft (150 m2). single-family home in Aptos, California charged a monthly rent of $1,800. In order to find the rent per square foot, the rent of $1,800 is divided by the area of 1,600 sq ft., which gives a rent per square foot of $1.12.
Another given 1,140 sq ft (106 m2) single-family home in Aptos, CA had a rent of $1,595 per month. Again, the rent of $1,595 is divided by the area of 1,140 sq ft., which equals $1.40 per square foot. So, even though this home has a lower overall rent, its rent per square foot is actually higher than that of the first home.
Factors Influencing Real Estate Prices
The variables that drive residential real estate prices can be grouped into macro forces and micro forces. Macro forces include mortgage interest rates, economic strength (the business cycle), demographics, and federal taxes. Micro forces include local economic strength, state and municipal zoning, neighborhood features (such as quality of schools), and the condition of the property itself.
The biggest factor influencing home prices are income levels. Home prices are limited in how far they can rise by the incomes of potential buyers. Since eighty percent of all homes purchased are purchased with a mortgage, the ability to make payments, borrow money, and the cost of borrowing money are major influences limiting how far prices can rise before hitting resistance due to prices hitting levels where potential are unable to qualify. In general the ratio in the US are home values at 2-4 times income levels.
Responsible lenders use what they refer to as a front-endť ratio which consists of income/mortgage payments to determine how much of a mortgage a person or family can qualify for and safely handle. This front-end ratio is generally a maximum of 28% of a borrowerâ€™s monthly gross income that can be allocated toward housing expenses including the mortgage payment, insurance and property taxes. For example, a lender would allow a person with a $5000 monthly gross income to allocate $1400 per month for mortgage payments, fire insurance and property taxes. ($5000 x 28% = $1400) So with $1200 available for monthly mortgage payments, after subtracting $200 for insurance and taxes, $1200 would support a $200,000 mortgage.
Real estate prices can have a profound impact on an area. They can cause urban decay, over crowding as well as an urban renaissance.
In Harlem and many other inner city areas of large American cities, real estate prices dropped due to lower demand and the resulting surplus in supply. This trend was largely caused by suburban migration. Lower real estate prices had a negative effect on landlords, who in these declining neighborhoods became known as "slumlords." Slumlords are notorious for not caring for the properties and letting them slip into a state of severe disrepair. Often, though, landlords in blighted urban areas did not have funds to care for their worthless and unprofitable properties. In many American slums, the situation became so dire that landlords were known to set their properties on fire in order to commit insurance fraud and collect the insurance policy payouts.
In some areas, rising home prices have caused an urban renaissance. Rising home prices can transform unprofitable and decaying properties into potential gold mines. In many areas, landlords renovated their now-profitable properties, while other properties were bought by developers, who renovated them, seeing the neighborhoods' potential. Many downtown areas of large American cities have enjoyed a significant reawakening of interest in inner-city properties, which has rejuvenated these once blighted areas. Thanks in part to rising real estate prices, many inner cities have experienced a true urban renaissance. This can lead to gentrification.
External Resources for Determining Real Estate Prices
- US Federal government quarterly reports on US housing prices
- Commercial real estate and pricing reports
- Monthly releases of existing home sales prices
- Monthly releases of new home sales prices
- Weekly residential real estate price trends
- House New Value Calculator
- Tools to Determine Housing Prices by Examining Fundamentals.
- Residential prices for western EU countries
- Math for valuing RE