Somewhere along the way people lost their common sense when it came to real estate. Houses that used to sell for $250k started looking attractive at $1m because everything else was selling for $1.1m. But while the prices of comparable houses in a submarket gives you some indication of the market value of a house, it doesn’t necessarily mean you should buy that house. The cheapest overpriced house is still an overpriced house.
One thing I like to look at is a simple comparison of rents and mortgage payments. Calculate the mortgage payment for a property you are looking at, then compare it to the rent of a comparable place. This can sometimes be difficult when trying to evaluate a large single family detached house, since there may not be too many comparable rentals in the area, but for a smaller house or a condo, you shouldn’t have a problem.
In my neighborhood, I’ve seen plenty of condos that are being offered as rentals for $2000-3000 a month. Assuming an interest rate of 5.25%, this payment would translate to a mortgage of $362,000-$543,000. Assuming a 20% down payment, this results in a house price of $453,000-$679,0000. Comparable condos actually sell for $550,000-750,000.
Looking a little wider, 2 bedroom single family detached houses are renting for $3000-4000 a month, translating to a house price of $750,000-$900,000. The asking price of these houses are still $1m and up.
This simple calculation doesn’t even take into account the additional recurring costs of homeownership: property taxes, insurance, and maintenance. Nor does it take into account the time or transaction costs involved when you happen to find a great new job and have to extend your commute or sell your house. Nor does it put a price on the risk of falling housing prices.
But never mind all that. Just keep it simple and look at the rent vs. mortgage payment as a starting point. Purchasing a house is a big emotional as well as financial investment, and emotions run pretty high when you’re talking about owning a piece of property with your name on it, providing a shelter for your family, and possibly regretting the biggest financial mistake of your life. By starting simple, you might be able to run a sanity check: Is the pride of homeownership worth a $100,000 premium on that small 2-bedroom condo? If you saved the $1000 difference every month in an ING Direct account at 1%, what could you do with the $61,500 you would save over 5 years?