What Price: a Home?

Recent housing market statistics have many asking if the housing bottom is at hand. This is an important question for many reasons, particularly the health of the banking sector, but a more important question for most individuals is: are prices right for me? Calling a bottom is a fool's game for most people, but that does not mean that purchasers can't determine a fair value for a home.

Housing has a rational price based on economic fundamentals, but this comes as a surprise to many. I hear people cite metrics such as comps (the price of a similar, or comparable, property in the same area), price per square foot, and cost to build. But in my view, the single best determinant of property value is the amount it would return as an investment. That is, how much money could you earn if you bought the property to rent to others (discounted using a risk-adjusted rate).

To those who believe that renting is just throwing money away, look closely at the statistics of the last few years. Most American home owners lost significant equity during that time and now may be upside down (the mortgage principal is greater than the value of the home). Home ownership entails many responsibilities, including property taxes, maintenance, mortgage, and insurance. By and large these costs do not exist for renters. Renters don't put 20% (or more) down for the "privilege" of ownership, an amount which can exceed $100,000 in many areas of this country for a very ordinary home. That amount of money would make a nice safety cushion for a rainy day. There are more than a few cons to renting, but I'll focus on the pros. Every year your lease comes up, which gives you the flexibility to move with no need to sell a very large and illiquid asset (a home). With that flexibility comes (potential) mobility in career, ability to take advantage of falling rents (of course, the converse is true as well), and limited downside should you lose your income--you won't lose your home and the significant savings you sunk into it.

The main tool used to value assets is the discounted cash flow (DCF) model, and there are many good resources for learning this (Aswath Damodaran's Investment Valuation is my favorite), but you could use rules of thumb as well. A good one is price to annual rent. The point is, however, that the value of a home should be based on fundamentals, such as the rent (and cash flow) you could generate from a home as an investment. Due diligence in evaluating value this way adds a level of protection in the form of healthy skepticism. After all, most home buyers can't afford to make such an expensive mistake, and it is possible to overpay, even in an environment of falling prices.

Healthcare Reform

I listened with great interest to President Obama’s health care speech tonight. No domestic issue more concerns me at this time. Economic recovery, education, and mass transit are all very important, but now is the time to focus on meaningful change to our health care system.

Any reform, however, should address coverage qualities currently lacking, particularly accessibility to all, portability, and economic viability. First, universal accessibility should be achieved. Health care should not be rationed based purely on ability to pay. Objections of fairness aside, most Americans could easily find themselves one bad day away from being cut off from essential medical care. This is a utilitarian argument. Second, our access to health care should not be contingent upon employment. Keeping my health care even if I lose or change my job would greatly enhance my ability to choose from a greater variety of employment opportunities. It would be easier for people to choose to work at small firms or non-profits if medical plans were independent of employment, adding much needed flexibility to our economy. Finally, it should be economically viable. What I mean by this is that the overall proportion of our GDP dedicated to health care should fall. Spending up to 18% of our national income on health care is far too much. Every 1% drop in that proportion frees up more than $140 billion to be reallocated to other (assumed) more productive uses. That’s more than $450 in savings for every U.S. citizen. If we spent in proportion to what Germany spends, that amount increases to more than $2,800 for every American.

Critics of the public option are again talking up the prospect of introducing more market based competition to drive value for U.S. consumers. Professors Michael Porter and Elizabeth Olmsted Tiesberg argued persuasively for a renewed effort in creating health care competition in their 2004 HBR article “Redefining Competition in Health care.” As one who believes in the power of the free market to drive better living standards, I find this position ideologically attractive. But the history of healthcare reform suggests otherwise. Attempts to introduce market based incentives have ended in dismal failure. How competitive a market is is a matter of national importance. Health care, for a variety of reasons, is not competitive. Because of this, we need government intervention and action in the form of a public plan.

I am willing to pay a higher share of my income in taxes in return for a health care system with the qualities outlined above. I am heartened by President Obama’s strong push towards health care reform. Let’s hope that he is successful in achieving his twin goals of reducing cost and increasing coverage. That would be forward movement indeed.

Introducing Guest Blawger, "Econoclastic"

Mr. Econoclastic, Sir Econoclastic, "EC"? ... this Guest Author will have to clarify his pseudonym when he posts next, but suffice it for now to indicate some details of his professional accomplishments will be hidden for the sake of Econoclastic's own business plans, and employment security with his current firm. I am really quite pleased, however, that he has agreed to write with us despite such pressure: he is our first MBA blawger, and a friend from a previous degree. Too, given his ongoing debate of opening his own shop, I am interested in the topics and details he'll discuss on this site.

Econoclastic works in Manhattan and lives within the Five Boroughs of New York City. He graduated from Temple University's Fox School of Business and Management, studying Economics. He is also a recent graduate of a Top 10 MBA program. Econoclastic currently works within the financial services industry, and among the professional organizations he remains active in is the Beta Gamma Sigma Honor Society and Alumni Group in New York City.

Welcome, Econoclastic! Am glad you're joining us for the next month, and I'm excited to read your posts!