Is your real estate market overpriced? Navigating today’s housing market isn’t easy. Though inventory is going up and mortgage rates are going down, property prices are still sky-high. For the real estate investor, it’s pretty easy to assess your local market. Things get tougher as you go further afield.
Investing in out-of-state markets means entering a different context relative to your own. What seems like a reasonable price in your context might actually be overpriced for the market. Here’s how you can tell!
You may be dealing with an overpriced market if you see plenty of price reductions on real estate listings. In isolation, these are just unrealistically priced properties. When there are many, though, the market has a pricing problem, and would-be buyers aren’t putting up with it. While this doesn’t mean the market should be totally written off by investors, they must have realistic valuations in mind.
Automatic valuation models are often employed by lenders and real estate professionals to determine the “actual value” of a property. In theory, a property will be worth what someone is willing to pay. However, it may be more accurate to say a property is worth however much a lender says it’s worth.
One provision commonly seen in the hyper-competitive post-COVID real estate market reflected this reality. Buyers would agree in their offers to pay a certain amount above what their lender determined to be the property’s value. Say a home is on the market for $300,000. Intense competition brings that price up to $350,000. However, the lender is only willing to lend $320,000 based on their valuations. The buyer can then say they will pay up to a certain amount above that valuation in cash to get closer to their original offer.
Obviously, this isn’t something investors want to do! In most cases, it’s better to walk away from an ultra-competitive situation rather than risk overpaying.
Examine both the price-to-income and price-to-rent ratios for the area. These compare costs (of housing and rent) with the median household income for a given area. If the ratio comes out high, real estate is relatively expensive. You can do the same for rent prices. Compare these numbers to historical trends. If it’s abnormally high, steer clear.
Many would describe the current real estate market as “frozen.” This is primarily attributed to high interest rates deterring buyers. Demand can drop for many reasons, though. Yes, real estate may be overpriced. It could also indicate poor economic conditions and a lack of job opportunities. The market isn’t attracting people. While it doesn’t mean the market is overpriced, it does make it riskier.
Finally, pay attention to what other investors are saying. Markets being hyped up may be too crowded (aka overpriced). Investors may also be able to tell you if they overpaid or regret investing somewhere. Listen to what the people are saying. Sentiment isn’t a rule but can guide a deeper investigation.
Generally speaking, investors want to avoid overpriced properties. As buy-and-hold investors, your primary exit strategy is selling the property in the future – ideally when it has greatly appreciated in value. Overpriced properties will eventually see a correction, effectively stunting your appreciation potential.
That said, there tends to be a close relationship between the cost of buying homes and their rental rates. Investors may find that an out-of-state market is affordable for them even if it isn’t so affordable in its own context.
Investors need to weigh the opportunity cost of paying more for a property and reaping the benefits of a high-demand rental market. Crunch your numbers! Investors want to avoid overpaying, but there may be situations where you’re willing to take that risk. Just be ever-mindful of the signs of market health, do your due diligence, and work with accurate metrics.
At the end of the day, only you can determine what opportunity is – and isn’t – worth your time.
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