Hearing the recent news that the monthly median house price has fallen for the first time in 40 years and 2007 was the worst sales year on record for new homes, you can’t help but wonder what the impact is on our own downtown slice of DC. The practical evidence comes in the form of foreclosure and potential short sales visible when contrasting active condo listings and DC real estate sales and tax records. The anecdotal evidence comes when talking to friends, walking through open houses or seeing reductions promoted in the Sunday real estate section. The question remains, what is my condo really worth? We’ll look at three measures that can draw a box around the answer.
Ed. Note: This is a longer and more technical post than usual but we thought readers would be interested in the subject.
Three measures for determining worth
Dollars per square foot (or ft2) – This one’s easy…take the retail price and divide it by the number of square feet. You should end up with a number between the mid $400/ft2 and upper $500/ft2 range. For example, 1010 Mass has brand new units at around $550/ft2. Hint: This is only useful for comparing prices among condos, not determining intrinsic worth. It’s a useful measure regardless of the condo’s size.
Price-to-rent ratio – For this one, take the price and divide it by the rent generated by the unit for one year (i.e. twelve months). Fortune magazine has a great article on the house price-to-rent ratios for major US cities, including Washington. Hint: Washington’s is still too high on a historical basis meaning prices need to come down or rents need to go up or a combination of both to get back to the average.
Capitalization rate – This is the opposite of the price-to-rent ratio. It’s the annual rent divided by the price and it’s expressed as a percentage. If that one bedroom condo generates $24K in rent a year and it costs $400K to buy, then the capitalization rate is 6%. Hint: Another way to think of this is that the condo’s full purchase price turns over in accumulated rent every 10 to 15 years.
How much is that 800 ft2 unfurnished condo that rents for $2K per month worth?
Dollars/ft2 – At $450/ft2, it’s worth $360K. At $550/ft2, it’s worth $440K.
Price/rent – At 26 (the current number for DC), it’s worth $624K. At 15.9 (the 15 year average for DC), it’s worth $381.6K.
Cap rate – At 5%, it’s worth $480K. At 6%, the average apartment rental cap rate in October 2007, it’s worth $400K.
This is merely meant to be a primer and ultimately a property is “worth” what someone will pay for it. You can’t always put a logical price on a great pad you call home. Nevertheless, realtor or not, it’s good to figure out the inherent economic value of any asset as backed by cash flows before jumping in or out. Two sites to check for price trends in DC are DC Housing Prices and the stats section of the GCAAR website. Interest rates are low (trashing our beloved dollar) but lending standards are now back to where they should have been (finally!) which will bring us all back to economic reality.
1) Parking and storage are being excluded from these calculations. Compare apples to apples by subtracting or adding in the estimated value of parking and/or separate storage. Amenity and condo fee differences can have an impact also.
2) Average real estate prices for a metro region represent a combination of neighborhoods and not just one neighborhood. Specific neighborhoods may do better or worse than the metro average. No price/rent ratios were available separately for condos so we went with the house number.
3) True cash flow analysis discounts inflation that takes place in the future. We’ve simplified this example by not discounting cash flows generated by rent.
4) Real versus nominal pricing was not considered. Real pricing accounts for inflation while nominal pricing does not. The price you and I see listed for a property is a nominal price.
5) The cap rate calculation was done on a gross basis not a net basis. This means we didn’t take consider the impact of taxes or condo fees which you do have to account for.
5) We suggest you do not listen to the economic forecasts put forth by the National Association of Realtors as they regularly tend to be too rosy.