How to tell if a property is overvalued

In the wake of the incredible house price boom witnessed in most of the developed world over the past decade, a lot of ideas have sprung up as to how to value a house ‘fairly’. The reason for this is that traditional methods, such as working out house prices as a multiple of salaries, or perhaps mortgage affordability as a pand of income, seem to have ‘stopped working’ recently.

There can be no doubt that house prices are .. ahem! .. at the top end of their range compared to traditional valuation methods, but don’t let anyone fool you that this is now the ‘norm’, or that a ‘new paradigm’ is in place. Such talk rightly marks the climax of an asset bubble, as witness the dotcom bust as the millenium rolled over. Many things can change as technology and societies develop, but basic human nature isn’t one of them, and the twin drivers of any asset bubble, fear and greed, are rather depressingly evident in this bubble too.

So if you live in an area where houses are trading at, for example, twice the historical sustainable relationship to salary, how can you tell whether this is ‘ok’ or ‘bad’? Easy. There is one relationship that has stood the test of time and wheathered all previous house price booms and busts – the relationship betwen the house as an asset, and the return on that asset.

What do we mean by this? Any asset has a ‘return’ – what you make for holding the asset. Houses traditonally ‘return’ in 2 ways – by capital appreciation (house price growth) and by rent (if you own a house, you could rent it out). As it can be difficult to create a simple equation that factors in both these elements indivdually, they are usually rolled together, to give an easy way of comparing the required sale price of a house against it’s ‘true’ worth.

Is it complicated? No. It’s simple. If the price of a