Where's the Bottom, where is the bottom, Supportable Demand, supportable demand for residential housing, declining prices, declining values,

WHERE'S THE BOTTOM?? HOW TO MEASURE HOW MUCH FARTHER PRICES WILL DROP IN YOUR AREA!!

The irrational exuberance of the real estate market from 2003 to 2006 led to people getting loans that they had no chance to pay back when prices finally began to decline in 2006. Since then, price declines in Southern California have ranged from -30% to -60% depending upon the market area.

So.....where is the bottom? - when are prices going to stop going down? The answer is really quite simple - prices will stop going down when the "average" buyer in a market can qualify for a loan for a property that is selling for a price that the average buyer can afford with their "average" income.

Mr. Steve Smith, MAI in San Bernardino came up with his "Measuring Supportable Demand for Residential Housing" for residential properties in September 2007. Mr. Smith is a fellow appraiser and good friend of our Company and has graciously allowed us to present his methodology.

The basic elements of this "measurement" can be made by anyone with access to the Internet and a financial calculator. The calculations involve:

Getting the House Hold Income from your area.
Getting the average or median price in your area.
Finding out the interest rate currently being charged for conforming loans
Making some simple calculations

Mr. Smith's spreadsheet that he came up with, which was updated by our company for this section, is presented below:

For those of you who don't want to mess with the calculations above, send me an e-mail & I'll send you the Excel 2002 Spreadsheet with the calculations already created. Fill out & send the e-mail request below. Be sure to tell us you want the Supportable Demand Spreadsheet.

It's really simple though - here is how to get the information:

Got to Realtor.com, or any other site to obtain the Household income for your particular area - usually your Zip Code. We used the Household Income for Diamond Bar Zip 97165
Plug in the number in the first Cell. Loan Underwriters usually consider that maximum Principal, Interest, Taxes & Insurance (PITI)should not exceed 32% of your total income. If you don't have the spreadsheet, multiply the Houshold Income by 0.32
Plug this number into the "Annual Housing Pmt. " Cell. This is the maximum yearly income that most Underwriters will allow. Divide this number by 12 & plug this number into the next Cell. This is the maximum allowable monthly payment allowed for PITI
Next, research what the loan interest rate is in your area - when this was being written, it was 5.5% in our area. You want to get the Loan Constant for that Rate. In a financial Calculator (available on-line also) clear the registers. Then put "1" in the "Present Value" Key, 360 payments (30 Years) in the # of payments key, 5.5% in the Interest Rate key. Now solve for Payment. You should get the number shown above.
Now divide the maximum monthly income by the Loan Constant. The result is the maximum supportable loan amount for the average income in the area for which you obtained the Household Income, in this case: $432,504.
Now we need to figure out what Down payment would be necessary. Again, we are trying to model the typical low-risk loan. Today a 20% downpayment is considered the difference between a low and high risk loan. The maximum loan payment we calculated in the last step = the 80% loan amount. So we use the formula: (432,504/0.8) - 432,504 = 108,126. $108,126 is the down payment that is necessary for a low risk loan with 80% mortgage and 20% down payment.
Now add the $432,504 + $108,126 = $540,631. What this means is that the "average" income in this Zip Code will support a maximimum value home of $540,631.
Now the interesting stuff takes place. Again, from Realtor.com, or if you're in Southern CA, the L.A. Times Price Survey (Sunday Paper) get the "Median Price" for the Zip Code your researching. As this was being written, the median price for 91765 was $451,000. Now subtract the median price from the maximum supportable sales price. For Diamond Bar, this number is negative, which means that based upon the data, Diamond Bar Zip Code 91765 has already reached the "bottom" where the person with the Median Household can afford to get a low risk mortgage on the Median Price house in the Zip Code.
However, let's carry on assuming that the number is positive. You need to calculate the percentage difference between the the maximum supportable demand and the median price in the Zip Code. In this case, it is $89,631/$451,000 = 20% Rounded.
Last step. From the L.A. Times Price Survey, Data Quick or other source, get the most recent % decline in the Zip Code you are researching. For Zip Code 91765, the most recent decline is -1% per month. Again, assuming you have positive numbers for the last 4 Cells, if your market is +20% overpriced by these calculations, and the area is declining -1% per month, that means that at current rates of decline, this market will be going down for another 20 months.

The actual way appraisers calculate the Sales Rates is to measure the actual "market segment" in which a property is located. A "Zip Code" can actually have several neighborhoods in it, each trending at different rates.

However, without access to better data, this is as close as the "lay" person can get. If anyone reading this wants a more accurate estimate as to how your neighborhood is trending, find a local appraiser who is proficient in using Statistics to measure market trends.

For an example of how this is done, see our "Econometric Analysis" discussion. Click on the colored words above.

(Other section not written yet, please come back - this page is still under construction)

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