A Case Study in Real Estate Valuation
Real Estate Scenario
Here is how
a typical real estate transaction works. You get an agent. You lay
out what you have to spend and the agent chooses the communities
with “good schools” and “good neighborhoods”
with homes in the n-bedroom range. After your agent suggests that
you need to spend 25 percent more than you wanted to, your agent
prints a huge wad of listings and you proceed to be carted around
to dozens of houses that aren’t quite right for you. Certain
neighborhoods are ignored because the agent has blacklisted them
for any number of reasons, some legitimate like true crime rates,
some not like fear of people not like themselves or turf deals.
Paying your share of the six percent real estate commission, you
buy a boring house in a boring neighborhood with nothing to set
it apart from any other neighborhood anywhere.
can’t afford these typical places anymore, or even where you
grew up. The typical way of doing things doesn’t work for
many average folks anymore. Four hundred thousand dollars for a
house that needs tons of work is not your idea of a good idea.
There may be
another way. This paper is not an advertisement for Laurence Harbor,
although it may serve as such. This document is an argument for
thinking about real estate differently, outside the existing rules
of buying (and selling) homes in which Laurence Harbor is the example.
Yes, yes, location
does matter. But location is to real estate as comedy is to sitcom;
in one era Friends is funny, in another the Golden Girls is. Same
with real estate; what one group appreciates, another might not
and new times brings new desirables in property.
How should one
value real estate in Laurence Harbor? Isn’t getting comparables
from your agent enough to tell you for how much to sell or buy a
house? As is the case in industries undergoing change or kids becoming
teenagers, what worked in the past might not work so well in the
future. This is especially true of Laurence Harbor as it is in a
History of the Raritan Bayshores and Laurence Harbor
had been considered, along with much of the Raritan bayshores, a
less desirable place to live until recently. Decades of neglect
and decline left behind much of the Route 35 and Route 36 corridor,
creating an unusual value inversion. Waterfront property was worth
much less than inland property, even though in many cases the schools
associated with the properties were the same.
of changes occurring in the corridor over the past century is the
history of the bayshores. For example, in the early 20th century,
Laurence Harbor used to be a golf course, with proximity to dance
halls and boardwalks along the Raritan bayshores. In the 1920’s,
the course was converted into vacation bungalows, like many towns
along the bay. Over the next 50 years, Laurence Harbor converted
to full time residents from vacationers. The houses were affordable
to those of limited means since the original bungalows were small.
Laurence Harbor and many communities resulting from bungalow conversion
were strong communities but with little extra means for improvement
With few exceptions,
the bay shore communities have remained working class communities
for most of last quarter or half century. However, the recent real
estate market in the New York Metropolitan Region is changing that.
As New York
and the metropolitan ring around it has experienced a resurgence,
demand for housing has grown outward from the city; extending north,
east and west into New York State; south and west into Pennsylvania
and west and south into New Jersey.
of commuter housing has extended far beyond where people had believed
it would. The distances traveled to get to New York City regional
jobs can be surprising, with significant numbers of trips being
generated from places as far away as Burlington County in New Jersey
and Pennsylvania resort towns in the Poconos. According to a Census
‘Journey to Work’ study released in March 2005, the
"extreme commute" of 90 minutes or more is among the fastest
growing segment of commuters in the nation.
your commute is tough?”, by Debbie Howlett and Paul Overberg,
USA TODAY, http://www.usatoday.com/news/nation/2004-11-29-commute_x.htm
for more info)
commutes are one sign that housing costs are convincing people further
outward to find housing suitable to them.
house and amenities can often be purchased in eastern Pennsylvania
than in northeast New Jersey for the same money, the cost in terms
of time lost can be significant. With millions in the region traveling
over an hour a day and a few hundred thousand at three hours a day,
Laurence Harbor and many other previously ignored Central Jersey
towns might be the solution.
offers so much besides a shorter commute. Among the amenities offered
by Laurence Harbor are:
Stores Close by
You can find
out more details about what Laurence Harbor offers at http://www.laurenceharbor.org/whylh.htm.
I buy a house at all right now, you might ask. After all, prices
have gone up all over the place and prices have to come down soon.
Everyone is saying we are in a housing bubble so it must be the
wrong time to buy.”
Its no wonder
you might feel this way. The press and media have oversimplified
housing cost issues so much that “housing bubble” reports
are almost meaningless.
a housing bubble?” is the wrong question. Are there regions
where a housing bubble exists? Absolutely. San Francisco, Los Angeles,
Washington D.C. and a few Texas cities are all potential bubbles
since housing values cannot increase for 20 percent a year forever
because family incomes do not increase at that rate forever.
writer of the book “Irrational Exuberance”, has been
conducting surveys in the field of real estate to identify potential
bubbles. One of his survey questions is "On average over the
next ten years, how much do you expect the value of your home to
change each year?" When comparing the responses of two cities,
Los Angeles and Milwaukee, he found that respondents in Los Angeles
said 22.5% on average, while those in Milwaukee said 13.4%. L.A.s
higher expected percent suggests it might be more prone to a bubble
and the subsequent bursting.
of the story not told in attitude surveys is, what about supply
and demand? A boring question with a useful answer. For example,
in places like Texas and Wisconsin where land is plentiful and cheap,
supply will keep up with demand for a long time. Bubbles, if they
form in places like these, can easily burst with dramatic price
drops. However, in places where housing supply is limited by tight
land supply, high construction fees and costs, and long commutes,
any bubbles are less likely and any post bubble corrections from
housing bubbles that do form can be expected to be less severe.
Has a real estate
bubble formed in the New York Metropolitan region? Even the New
York Metropolitan region may be too large an area for a definite
yes or no, but most of the region has simply experienced a recovery
from the previous recession.
A Long, Great
Explanation of New Jersey’s Residential Situation
telling of the story of the northeast’s and New Jersey’s
last bubble, and the story of our current situation is told by James
Hughes, Dean of the Edward J. Bloustein School in “Housing
Bubble or Shelter-Safe Haven?” at http://policy.rutgers.edu/rrr23.pdf.
entire report is a must read primer on real estate bubbles anywhere,
excerpted here is the core description of the previous New Jersey
bubble and the recent recovery from that bubble:
standard for a housing bubble is probably the 1980s home-price
boom in New Jersey. Extraordinary price gains far in excess of
inflation, combined with vast differentials between the rates
of house appreciation in the state versus the nation, led to unsustainable
house prices rose by 109.5 percent between 1983 and 1988, with
1988 standing as the market peak, as measured by the House Price
Index of the Office of Federal Housing Enterprise Oversight. For
five consecutive years, prices of New Jersey homes grew by almost
16 percent per year on a compound annual basis.
over this same time house prices nationally rose by only 37.4
percent, or by a compound annual growth rate of 6.6 percent. Thus,
New Jersey’s house price gains on both measures were nearly
two and a half times that of the nation. This type of sustained
relative performance—or excess—certainly qualified
as a “boom” and, as events would ultimately show,
rates of increase did not prove to be sustainable. New Jersey
house prices peaked in 1988 and then declined through 1991, with
a total price decline of 7.8 percent, or –2.7 percent on
a compound annual basis.
markets are “sticky” on the way down, at least compared
to equity markets, this decline may not have fully revealed the
scale of correction. In contrast, home prices for the country
as a whole continued to rise, although slowly.
period, national prices increased by 8.7 percent, or 2.8 percent
on a compound annual basis….The punch bowl was definitely
removed from the [northeastern] regional housing party.
began to recover very slowly as the national and regional economies
emerged from the early 1990s recession. But housing in the region
faced a long road back. It actually took until 1998 for New Jersey
to return fully to its nominal price peak of 1988. Thus, the recuperation
period constituted a full decade.
was in nominal dollars. After adjusting for inflation, 1998 home
prices in New Jersey were still considerably below those of 1988
since inflation increased by 32.6 percent between 1988 and 1998.
In constant dollar terms, the real house price in New Jersey in
1998 was still 32.6 percent less than in 1988—or nearly
1998, a number of factors were building in the Tri-State Region
and in the nation that would contribute significantly to the next
surge in house values. New Jersey’s home prices jumped by
51.7 percent between 1998 and 2003, or by 8.7 percent per year.
This was nearly
four times faster than the annual increase in the CPI (2.4 percent).
This was also considerably above the comparable national rates
of house price increase (38.0 percent and 6.7 percent, respectively).
It took the
first four years of this recent period of rapid home price appreciation—between
1998 and 2002—for the inflation-adjusted price index to
finally top the peak of 1988. Thus, in real terms, it took a full
14 years, to 2002, for complete price recovery. In this context,
the notion of a housing bubble tends to lose credibility, since
the post-1998 price surge enabled us only to recover the price
declines of 1988–1991 and to compensate for 14 years of
So it difficult
to designate this recent price surge in New Jersey as a bubble.
Another important piece of evidence arguing against a bubble is
that the 8.7 percent annual compound rate of growth for New Jersey
in the five-year period between 1998 and 2003 is barely half of
the 15.9 percent annual growth rate of the 1983 to 1988 boom.
in the earlier period (1983–1988), the annual rate of price
increase in New Jersey was more than double the national rate.
Currently (1998–2003), it is not even one-third higher.
Thus, if the 1980s experience sets the threshold for a bubble—in
terms of high general rates of increase and high rates of increase
relative to inflation and the nation—then we conclude
that the current experience is not a bubble. [ed. bold]
In the long
run, housing price increases cannot consistently outstrip growth
in housing buying power. Surrounding the 1980s housing boom was
a period of strong relative income growth, with incomes in New
Jersey growing far faster than the nation’s. But even this
growth ultimately could not sustain the boom years’ price
prices having recently advanced far faster than income growth
during our current home price boom, some apprehension again appears
to be warranted. However, declining interest rates have transformed
the unexceptional recent income gains into much larger increments
of housing buying power, justifying part of the home-price surge.
rate declines to levels not seen in more than 40 years are now
themselves history. Thus, all of the gains in housing purchasing
power as a result of interest rate reductions in the current market
probably have been made. Future income growth from this point
forward will be the major determinant of housing-buying power
gains. How much this will reduce the rate of increase in prices,
or even cause them to sag, remains to be seen because so many
other elements are also present.”
The above report
was finished in early 2003. As we know, the housing market, in New
Jersey and the nation, has continued to astound even the most optimistic
of housing prognosticators.
for the continued performance of the residential housing market
are mentioned earlier in this article and include eliminating the
extreme commute and improving access to jobs and other amenities.
Reasons for paying more for a home, if the price is right, can be
or data nationally or locally might tell us where the housing market
will go next?
Areas with population
growth will continue to see strong markets, though not necessarily
rising housing prices. In the last Census, New Jersey surprised
demographers the world round by gaining enough population to keep
all of its House of Representative seats.
It is important
to differentiate between areas with growing populations. Population
growth in areas with plenty of housing supply cannot sustain continuous
large price increases. New Jersey will probably be the first state
to use up the majority of its land, also known as “build-out”.
With land supply rapidly diminishing in the populated and high density
northeastern portion of the state, this land supply constraint will
certainly raise the value of housing beyond what it would be in
other similar regions where build-out is much further off.
Add to this
the rising cost to build housing and New Jersey is in the top ten
in terms of the aggregate costs to build homes. These costs can
include labor costs, fees, land prices, materials, infrastructure
cost share, and codes and rule adherence.
income growth has put New Jersey into the top position as the state
with the highest per capita income in the nation according to the
last Census. Over the past decade and a half, salaries not only
recovered from the late 1980’s early 1990’s recession
but have been powered forward by very strong growth in the pharmaceutical,
financial and information technology industry.
common as well is the cash-out mortgage, home equity loan, and the
home equity line of credit, where homeowners take some, all or more
of the equity (value of the home above the remaining mortgage amount)
out of their home for home improvements, investments, vehicles or
some other purpose. This equity growth has assisted in powering
income growth beyond that of simple wage increases.
in homes has also allowed the potential homebuyers to buy homes
that might have been previously out of reach without large amount
of equity from their existing homes.
James Hughes suggests, interest rates had risen from their lowest
in forty years since the report was written, they stabilized not
too far above their lowest levels, and have stayed there for two
and a half years and counting!! Currently, the 30-year mortgage
rate is around 5.75 percent depending on the fee structure and type
of lending institution you are borrowing from, up only a percent
from the forty year lows mentioned earlier. This continued low interest
rate environment means that all else being equal, a given home buyer
will be able to buy more house for the same amount of money.
a homebuyer who wants to buy a $225,000 house with 10 percent down
($22,500) makes the loan $202,500. A 30-year mortgage at 5.75 percent,
with a $3,000 property tax and $300 property insurance on that house,
would cost $1,527 a month. At one percent more on the mortgage,
6.75 percent, the monthly payment goes up to $1,659 or $132 more
a month. Low interest rates mean more house for the buck. To do
more of these calculations, you can use the Monthly Payment tool
So Why do Home
Prices Vary so Much?
While the above
data may argue for a housing market which in aggregate will continue
to be strong, what determines the relative valuation differences
between states and even regions? Why is a two bedroom house in rural
Alabama $35,000 and a similar house on western Long Island, New
The reason is
that an aggregation of the above factors (income, supply & demand,
etc.) and others like school quality, combine to result in a valuation
of a home. Long Island is much closer to a million six and seven
figure jobs in the world’s leading businesses. A homeowner
living in rural Alabama would be hard pressed to find many jobs
cracking the $25,000 dollar mark.
on eastern Long Island, if so inclined, could drive or commute to
work in under an hour. The person in Alabama would be hard pressed
to find jobs close to home, and would need to drive greater distances
for better pay.
Access to New
York City, with one of the world’s greatest concentrations
of cultural amenities, is valued by the market much more highly
than rural Alabama. This is NOT to say that Alabama is not a wonderful
place to live, only that there are many more people with more money
vying for houses in the New York metropolitan area than rural Alabama.
In fact, many rural areas across the United States, Florida, and
even Belize are popular places to retire because the cost of living
is lower and there are many amenities desired by retirees, particularly
Bubble or Undervalued?
there is absolutely no doubt that Laurence Harbor was significantly
undervalued. A recent article in the newspaper - LIVING IN/Laurence
Harbor, N.J.; An Old Haunt Re-emerges on Raritan Bay - http://www.nytimes.com/2004/12/26/realestate/26livi.html,
quotes a local marina manager; ''A few years ago, it was a million-dollar
view that nobody wanted,'' Mr. Johnson said. ''You couldn't give
houses away for $70,000. Now, they are sold to relatives or friends
before brokers hear about them.'' (If the above link doesn’t
work, try visiting this page, http://www.nytimes.com/top/classifieds/realestate/locations/newjersey/,
and click on the link for “And Old Haunt…”) Even
waterfront homes regularly went for under a $100,000 until recently.
can’t buy a home for $70,000 anymore, prices are still well
below the median price for the region. But the price increases for
homes in the area are not all due to the rising real estate market
or the “discovery” of Laurence Harbor as a water front
mecca. Laurence Harbor’s value is also increasing due to a
renaissance which has begun to show off a much-improved community.
of home renovations are going on around the harbor. New 2nd floors,
dormers and entirely new homes are being added. At times it seems
that half the homes in Laurence Harbor had new siding put on in
the past couple years, albeit all tan.
A new waterfront
park was completed recently, and another phase is being added as
this report is being written. Road improvement projects such as
lane additions, on and off ramp improvements, and toll removals
are being carried out on most major highways in the area, making
for better commutes all around.
one might pay twice what one might have paid ten years ago, homes
can still be considered very reasonably priced. Where in central
and northern New Jersey can you get a home for $200,000?
of the newly rebuilt waterfront homes has been put onto the market
yet, so values for waterfront homes is only estimation by appraisal.
This is important, because the appraised values of mid-$300,000
range is still extremely favorable when compared to the many very
expensive new homes available in South Amboy City just northwest
up the Raritan shore line. The least expensive new homes in South
Amboy are town homes going for $500,000 for condominiums near the
water and many of the choicest single-family homes are topping a
have an affect on the values of the other houses in the area and
will continue to exert upward pressure on the rest of the homes
in Laurence Harbor.
& Hidden Treasures -- Laurence Harbor Real Estate Listings
Harbor is rediscovered, listing challenges are being discovered
as well. Although the challenge was even more widespread previously,
even now, rooms are left out of descriptions while at the same time,
houses smaller than a single wide trailer are divided up into five
by five foot rooms so they can be hinted at being “five bedroom
palaces”. As with many former vacation homes that have been
added on to over the years, many front and back porches are unheated
but fully enclosed and insulated. A bedroom may be a fully divided
room, with doors and closets or it might be a large room with different
carpet dividing the room in two. Do not limit yourself to viewing
two bedroom homes because that is what your agent says. Look at
large single bedroom homes or ones with lots of rooms as well as
less expensive three bedroom homes that could be converted back
to two bedrooms.
This leads to
a reminder in your real estate ventures: do not rely too strongly
on “comparables” in Laurence Harbor. Comparables are
the home sales of houses in your price range, size, lot configuration
and neighborhood used to help price out homes you are considering
buying or selling. Although comparables work fairly well in large
tracts of similar homes, where home size, shape, configurations
are very similar; it works very poorly where these factors vary
greatly. Where lots can be as small as 25’x50’ or as
large as 200’x150’ and everywhere in between, extra
land might be valued at a higher premium than in other more traditional
neighborhoods. Also, where most homes do not have a basement, a
basement might add a premium to a home. Although on street parking
is plentiful, a driveway could be a useful bonus when buying a house,
especially if one had plans to expand the homes foot print.
The Hunt for
Undervalued Real Estate
is a gem in the rough, and there are many more communities to be
discovered which are also undervalued gems. To find these communities,
you should look for:
- Large price
differentials between nearby communities
- Access to amenities which have not been priced into the market
- Traits and characteristics not accounted for by the market price
and the limited databases that make up the Multiple Listing Service
Be careful that
you stay realistic in your expectations for price appreciation,
income, and amount of work in being a “real estate mogul”.
But if you are logical and realistic, your efforts can be rewarded
handsomely, either in finding a home for yourself or buying investment
properties. A little extra time spent examining communities and
homes, and not just listings can net you a better property for your