A thoughtful New York Times article by Damon Darlin highlights new research from a pair of Pomona College economists on how to evaluate whether homes are fairly priced, by comparing home prices to rents. While price-to-rent ratios have been calculated before, the Pomona research is more sophisticated in at least two ways:
1. Pair-wise comparables vs. aggregate indexing: the professors attempted to find rental properties comparable to homes for each area studied. Previous comparisons took all rentals, which included studio apartments, and compared that to prices of all single-family homes, which included mansions. This created errors because most mansions aren’t for rent.
2. The professors considered a property’s *future* rent-generating capacity to determine the net present value of the property (that is, what it’s future rent-generating capacity is worth today, on the premise that a dollar now is worth more than a dollar later). This is how investors evaluate stocks.
What’s interesting about this is not just the conclusion, that some markets such as Los Angeles may not be as over-valued as once thought, but the methodology. Real estate agents and real estate Web sites that have traditionally produced CMA’s (comparable market analysis) from a list of previously sold homes could begin to incorporate into their analysis rental properties, which would help consumers figure out not only if the home is fairly priced compared to other homes — is every other home-shopper as crazy as I am — but if the market itself is over-priced.
Ten bucks says that the article will be among the five most-emailed articles published by The New York Times.