
Ask HN: The difference between “overvalued” and “that's how much it is now”? - jlelonm
I&#x27;m particularly interested in housing prices, but if it&#x27;s different for other industries I&#x27;d love to understand that as well.<p>It&#x27;s strangely hard to find a good answer. Googling yields &quot;housing is overvalued (2011)&quot;, ... &quot;housing is overvalued (2014)&quot;, ... &quot;housing is overvalued (2018)&quot; but with no particularly rigorous explanation on why, nor the difference between &quot;overvalued&quot; and &quot;yep, that&#x27;s normal now&quot;.
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andrewstellman
One of the biggest misconceptions about markets is that the most recent trade
price is the current value. But that's not actually true – it's approximately
true in heavily traded markets (like S&P 500 stocks). But for a much less
frequently traded market (like brownstones in Park Slope, Brooklyn or
apartments in downtown Minneapolis) where there are only a handful of
transactions each week, the price doesn't actually reflect value. It reflects
the most recent price paid – and if there aren't a lot of buyers, then the
actual value is lower than that price.

Most people who have done a lot of options trading have seen this in practice:
if you're trying to sell a really thinly traded option RIGHT NOW, most of the
time the latest price is a higher than the price you'll get. That's because
there was only one buyer at the time, and someone else got that person's bid.
So now you'll have to go to the next-most-interested buyer, and you'll
probably need to lower your asking price a bit because otherwise he or she
would have been the most recent buyer.

All of this is masked in heavily traded markets. But it's a lot more apparent
in housing. However, that's complicated by the fact that people REALLY HATE
lowering their asking price, so instead of seeing prices drop, housing markets
typically just see volume go down. And recent lower transaction prices are
often dismissed by sellers ("That person was just desperate to sell, I'm going
to wait for someone to pay what my house is worth").

~~~
Bedon292
They hate selling it for less than what they payed for it as well. Even if the
market will not support that price any more.

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the_gastropod
Valuation of assets typically is a function of how productive the asset is. In
the case of housing, it's best to assume you're renting out the property. If
you can rent a property for ~12% of the cost annually, that's probably a
pretty decently priced house (your returns after maintenance, taxes, etc.
would be pretty close to something like the S&P500). If you can only rent for,
say, 5% of the cost annually, some might say the house is overvalued.

~~~
keredson
In the Seattle far-suburbs I'm renting at 3.36% by your metric. And people
keep asking me "why don't you buy?!?" THIS. :)

~~~
badbug
Buying isn't always the best option but don't forget about potential
appreciation and tax write-offs in your financial decisions.

~~~
stevewilhelm
People also forget the costs of selling a home. For example, sellers usually
pay a realtor commission of five to six percent of the final sales price.

~~~
toomuchtodo
The seller's commission is always negotiable, but 5-6% is customary.

------
mikeash
“Overvalued” is speculation about the future disguised as a factual statement
about the present. The difference is whether the price will eventually come
crashing back down. If it will, it’s overvalued, otherwise it’s just the new
normal. Of course, that means you can’t make that distinction with any kind of
certainty until long afterwards.

~~~
AnimalMuppet
It could be speculation about the future. Alternately, it could be a claim
about an (at least somewhat) objective standard of value.

"Stocks are overvalued." How do you know? "The price to earnings ratio is too
high." Now the question is, how good a measure is the price to earnings ratio?
Is the "right" price to earnings ratio determined by the historical average,
or does "right" change with changing circumstances?

I don't have any solid answers about whether stocks are overvalued. (My
personal guess is that, in a time of very low interest rates, a high P/E ratio
makes the rate of return on stocks comparable to the rate of return on bonds,
and so stocks may in fact not be overvalued. But I'm not an economist or a
stock trader, and I could well be wrong.) My point is that there are _some_
at-least-somewhat-objective measures of whether some things are overvalued.

~~~
mikeash
There are objective measures, but how do you connect those objective measures
to the price? In other words, how do you decide that a certain P/E ratio is a
good objective measure, and counting the number of napkins in the company
cafeteria is a bad objective measure?

In the end, it’s just another layer on top of the speculation that the price
will come down in the future.

~~~
AnimalMuppet
Well, for P/E ratio, we have a century or more of solid data. We also have a
plausible reason why it might be a measure of how overvalued stocks are. For
napkins in the company cafeteria, not so much (by either measure).

The case against the P/E ratio boils down to "this time it's different". That
can in fact be true... once in a while. Not nearly as often as it's claimed,
though.

That doesn't mean that P/E is absolutely correct - just that it's somewhat
better than random noise.

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Eridrus
IMO Overvalued usually implies a comparison to something else.

For housing you could compare to: cost of renting, cost of in-fill
construction, salaries in the area, cost of alternatives (eg moving, to other
neighborhoods or cities).

I think these housing headlines are also basically asserting that prices will
fall, which clearly hasn't been true, but is a valid statement of belief.

~~~
kspaans
Yup, probably the simplest objective metric to calculate is price-to-income
ratio as a measure of "overvalued" in a given location.

~~~
TheTrotters
Not really. There's no universal law which says that bread has to be X% of
local income or that housing has to be Y%.

~~~
kspaans
You're right, interpreting whether a given price-to-rent ratio is overvalued
or not is subjective, but calculating that ratio is (mostly) objective and can
make for an apples-to-apples comparison between different locations.

------
Superleroy
The problem here is a little more complex than one might think at first.

Usually when something is overvalued it means that the value it has been given
is higher than what people are willing to pay, resulting in a product which
has been assigned a value nobody is willing to pay. This is not always that
clear cut, as some things have different values to different people. What is
overvalued and probably overpriced for one person might be well within reason
for someone else.

The housing market is very dependent on the location you live in so wihtout
further information it's hard to say if a house is "overvalued". The price is
normally closely related to the property price, so while housing might not be
overvalued, property prices could very well be.

Then there are different considerations regarding the longevity of your assets
(aka your house). Most things you buy are rather short lived, this is not the
case for property, which can be inherited over multiple generations.

You also have to consider that the amount of land is limited (within cities)
and owners/sellers are not necessarily companies trying to make a profit, so
"normal" supply/demand doesn't necessarily apply in these situations and
producing more (land/property) is just not doable. This also means that
renting prices usually increase similarly to housing prices.

There are lots of other variables here to consider but even regarding only a
few of them its already really hard to say what a house or property is
"worth", so what you should much rather be asking is "what are people willing
to pay/how much can they pay". If that is your question you could look at
default rates and newly approved credits to determine whether people are able
to pay for their house.

------
zoomablemind
'Overvalued' or rather 'overpriced'?

Real estate just as any other market instrument can be objectively overpriced.

Asking price is often set higher to pad for negotiation, as giving a discount
is a phychological incentive for a buyer.

As for 'overvalued', that's seems to be a subjective concept. Value is static
until it's exercised. If you hold a $100 in your wallet, it does not matter
(save for a fear of losing it) until you show someone else that you have it,
as basis for some value transaction.

Can you overvalue a $100 ? Sure, make it a collectible, put a celebrity's
signatue on it etc. Provide future reasons for it to hold a higher value. Use
it as a basis to borrow $200 (even though that $100 may have being borrowed
itself).

In a way, real estate has become a fiat just as the actual currency is. While
the dollar is a short-time instrument so its value could be exercised
immediately, real estate functions as a long-term instrument to transact for a
future value. That value is in form of taxes for government, interest for
banks/lenders, rent cash-flow, or a potentially higher selling price for the
owner.

As for the owner-occupied house, it can be seen as being more a liability than
an asset.

Do you believe that a newly listed property does not hold your expectation of
its future value? Well, the seller has not promoted that value to _you_
convincingly enough.

------
docker_up
You can't claim "overvalued" unless you have a model that tells you what the
price should be. That's all the difference there is, really.

Everyone telling you that housing prices in Silicon Valley are "overvalued"
really are saying "it's too expensive for me". But they have no data to back
it up, so they're declaring something with no proof or evidence. In order to
do that you need a model to show you what a fair price should be based on the
model, and how the market has deviated from that model.

~~~
lotsofpulp
The only thing that tells you what prices should be is an active market place
where transactions (proportional to the number of market participants) are
happening. If sellers and buyers are in agreement about the price of
something, then the only other way I could see one defining overvalued (and
undervalued) is over a certain time period, but then you would also have to
classify what class of assets and level of risk you are comparing it to.

But in most cases, "overvalued" and "undervalued" are meaningless terms for
when someone can't afford something, or someone doesn't want to sell something
at a lower price.

------
CamTin
It's not strange at all that there's no good answer, because if it were
commonly available knowledge that something is overvalued, it wouldn't be
overvalued. All investment is gambling, even housing. If you don't have a
strong opinion that you are willing to bet (big) on, don't buy. Nobody can
tell you the answer. If they could, and they were sure about it, they would
make a bundle betting with borrowed money instead of telling you.

------
charlesdm
For investments it's generally to do with 1) the risk of holding the asset, 2)
the potential return on the capital invested, and 3) the difference on returns
between asset classes.

Two examples: I can invest $1m into one or multiple properties. Depending on
the location, I will get some yield on that capital invested -- e.g. 5% per
year from capital appreciation + rent.

There are other locations where the return might be less than 5%, or more than
5%. But there are generally are reasons for that (the yield of investing in
property in NYC will be lower than if you invested in say, Kiev Ukraine). It's
risk reward.

Tax policies, for example, might incentivise local owners (who actually live
in the property) to buy property where it is unrealistic for an investor to
make money on -- if yields are 1 or 2%, one could say it's overvalued (unless
we are talking about unique buildings in prime locations that are unlikely to
ever decline in value).

Now a different situation: assume the stock market has declined by 40%, but
property prices have not. One could say property is overvalued then (i.e. not
the best asset to invest money in). As the spread between valuations and
yields between different assets increases, some assets could be overvalued
when comparing them to others.

------
candiodari
Start here:
[https://www.youtube.com/playlist?list=PLUkh9m2BorqkNzSSPrCDk...](https://www.youtube.com/playlist?list=PLUkh9m2BorqkNzSSPrCDkO2jlufVCinVw)

This is a class on valuation. Very interesting and teaches a lot of important
concepts.

------
maxxxxx
I think with housing you could consider it as overvalued because the product
hasn't changed much while at the same time its price has increased a lot.
Another indicator could be that for most people the share of income they need
for housing has increased. In 2008 an indicator may have been that a lot of
people relied on ever increasing prices in order to afford their mortgage
debt.

But in the end "value" is highly subjective so there is no clear method to
determine if something is overvalued.

------
iambateman
As you know, there’s a difference between price and value. A price is the
inefficient maximum of what the market will pay for an asset. So if there’s an
influx of wealthy people to an area (or cheap subprime credit), properties
will ride a wave up as those credit-flush buyers compete for a limited pool of
homes.

But my home doesn’t generate cash flows, so it’s impossible to say the home is
“over valued” because there is no objective benchmark. Perhaps someone is
selling my great grandfathers homestead. it will be “valued” more highly by
me, and I may “over pay” because I want _that_ property. Or there is only one
property available per year in a small neighborhood and I _must_ have it. The
value is psychological.

At a market level, look at the percentage of household monthly income spent on
housing to gauge the market’s mood. If that strays from historical norms, it’s
possible that the market is temporarily overheated.

Keep in mind that historical trends are distorted by the recent zero-interest
rate policy from the Fed, too.

[https://www.pewtrusts.org/en/research-and-analysis/issue-
bri...](https://www.pewtrusts.org/en/research-and-analysis/issue-
briefs/2016/03/household-expenditures-and-income)

------
everdev
In a free market, things can only be "over valued" if the buyer is
misinformed. If a home buyer believes that housing prices will go up 10% next
year, but in reality they stay flat, they are apt to over value houses.
However, if they believe prices will rise 10%, but they end up rising 20%,
then they under valued houses. You can only know in retrospect if something
over valued because the term implies a future outcome.

The other problem is that free markets are self correcting. Home buyers can
bring down prices if the majority simply believe they will drop and refuse to
offer asking price. So, anything believed by the majority of purchasing power
becomes self-fulfilling in dragging prices in that direction.

With the current housing prices, the majority of purchasing power believe that
houses are under valued, which is why prices continue to rise. Prices will
continue to rise until the majority of purchasing power believes that houses
are over valued. Only history and an arbitrary future reference point will
tell us if they were right or not.

~~~
pbhjpbhj
It's the "maximum price the market will accept" pricing you describe the only
possible pricing method in a free market in your opinion?

Over-valued could be that players in the market are able to raise the price
through, for example, manipulation of scarcity (actual various types of
scarcity may be the only way?).

Or it could be that the seller seeks a certain profit that is [viewed as]
excessive compared to the labour and material costs. The product is desirable,
but the capital holders control the price ensuring large profit whilst keeping
low wages for those who are actual creating the value.

House prices in the UK were hugely inflated by the buy-to-let market which
increased scarcity of buying options whilst simultaneously increasing rental
costs in order to cream off more wealth from the poor tenants and pass it to
the middle classes. Rentals became overvalued because now the cost includes
not only the cost of provision of a home but the unnecessary cost of paying
your absentee landlord an investment premium. The middle class cornered the
market, by generating an artificial scarcity of affordable housing.

The more wealthy can buy high street property -- keep rents high, occupancy
doesn't matter because they get a reasonable return in asset value just by
sitting on the property. High Street rentals are over valued.

~~~
lotsofpulp
Capital holders can only ensure a large profit because those who are creating
the value aren't themselves valuable. The value (price) of something is how
much a buyer is willing to pay, not the value it provides to the buyer.
Therefore the low wages are due to a surplus of labor. Not that this is a good
thing, but I think it's important to point out because if we want to fix low
wages, then we have to target the supply of labor. Give people mandatory six
weeks of paid leave, 1 year of maternity/paternity paid leave, and watch wages
go up automatically as capital owners have to adjust to less supply of labor.

------
pjmorris
Two thoughts on housing:

1) One component of housing is how much money banks are willing to loan for
the house. So 'easy money' environments will boost prices, apart from the
quality and size of the house, the desirability of its location, and the
circumstances of the buyer. In the mid 2000's, a lot of loans were made based
more on bank's willingness to lend than on the other factors.

2) To hold on to a house, someone has to pay the carrying cost. If the
carrying cost goes up past the ability of the owner, the house is sold or
foreclosed on (or rooms are put on AirBnB, etc). In 'easy money' environments
like the one created in the early 2000's and sustained since then, carrying
costs have been kept low. If they go up, as they did briefly during the
financial crisis, house prices will drop. The pattern seems to be to keep the
money easy, so it's hard to say house prices are too high, even though their
traditional relationship with income is out of whack.

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skh
Overvalued on a personal level means something costs more than you are willing
to pay and you can do without said thing. That’s how much it costs means you
think it’s too expensive but you really want it or feel you can’t do without
it and you can’t find an acceptable alternative for less.

I think housing in my area is overvalued because what I can afford to buy
would be a step down in terms of comfort from what I can rent. I looked at
some houses and checked tax records for sales history and notice a lot of
houses were selling as if they grew in value 8% compounded annually. This made
me think I would be buying high. I might be wrong but it feels to me that
houses are overpriced. I could be wrong of course. Maybe prices increase at
their current rate for 10 years. But it seems to me that the increases can’t
be sustained given the situation in the country (USA).

------
abannin
Whether or not the price falls within your expected range. Prices can rise
faster than someone's perception of the price range, so the conclusion is that
the asset is "overvalued". In other words, "overvalued" is a subjective
conclusion that is weighted by human biases. What may be "overvalued" for one
person might be "undervalued" for another. Another key component is the
perception/faith of asset growth. Can the price of the asset continue to rise?
If yes, then it is "undervalued".

------
clairity
on a national level, the case-shiller index should give you a good baseline
for how a home's price should appreciate over the long term. homes should
basically trend with inflation and, to a lesser extent, population growth
(until space or other resources become a constraint hundreds of years from
now).

hwever, local market conditions dictate the volatility around that trend line.
SF, for example, is space-constrained, demand-driven, and limited by zoning
and other regulations, so house prices will be high relative to historical
trends.

appraisers use 3 methods to triangulate the current valuation of a house: (1)
cost approach (how much it costs to buy the bare land and build on it), (2)
sales comparison (finding recent sales for homes similar to the one you're
valuing), and (3) income approach (typically the discounted cash flow of
rental income). how these three approaches are combined to come to a final
value is more art than science.

basically, just like economic bubbles, you can only know for sure after-the-
fact if something was overvalued. you don't have enough statistical data to
know if something is currently overvalued rather than within the normal
volatility of the asset price.

(i used to manage the leading cost approach product)

~~~
Bjartr
Does energy efficiency get considered in the valuation at all?

~~~
clairity
yes, but mostly indirectly.

both cost to build (both materials and labor) and sales price will be a little
higher, typically.

------
xiphias2
Housing is overvalued because the interest rates are very low compared to what
you can see historically. A lot of people are expecting a serious credit
crunch in the next few (max. 10) years which mean that housing prices will
decrease significantly compared to the current prices.

~~~
laythea
And then we can tell our kids about the great crash of XXXX, in the same
manner as we were told by our parents.

Some things are cyclic and out span most people's memory/life.

Luckily, humanity learns from its mistakes, and people write down what
happened in history, so we don't need to worry about where we are going.

~~~
HBlix
Writing things down is nice, but is sadly inadequate unless enough people
later _read_ what was written, and in a timely fashion, and the act on it.
Otherwise you just have what we’ve dealt with for millennia, a record of
history repeating itself.

------
peacetreefrog
For a lot of economists price == value, so it doesn't really make sense to say
something like a house is overvalued. This is particularly true with liquid,
well traded securities like US equities. That's not to say the current price
(value) won't ever change but -- generally -- you can't make consistent,
exploitable predictions about them. Prices for equities generally take a
"random walk" from where they are at any given moment.

For an interesting discussion about when and when this isn't the case the book
Inadequate Equilibria by Eliezer Yudkowsky is pretty good.

[https://equilibriabook.com/](https://equilibriabook.com/)

~~~
g_delgado14
Interesting. What about in the case where something clearly doesn't have the
value that the price says - i.e. the dutch tulip bubble?

~~~
decentralised
It's the same answer. The idea is that the free market acts out its own price-
discovery mechanism and assets are valued in relation to what speculators /
investors are willing to pay for them.

This is an interesting segway into auction theory and Dutch vs English
auctions in particular, if you are interested:
[https://mikebrandlyauctioneer.wordpress.com/2012/07/29/engli...](https://mikebrandlyauctioneer.wordpress.com/2012/07/29/english-
auction-versus-sealed-bid-and-dutch-auctions/)

~~~
pbhjpbhj
* segue

I only realised the pun in the product name when I first saw someone make this
homophonic substitution error.

~~~
decentralised
Thanks!

------
timwaagh
housing isn't just a financial investment. people factor in the benefits of
living at a certain place over just the investment value. to a person who will
live and earn a big salary at a place with a lot of good jobs or send their
kids to good schools, the place is worth a lot more than to a landlord who can
only rent it out. of course that can push rents up, letting investment value
catch up, however that's only the case if there is no supply.

------
stephengillie
Value is an expression of utility. "Overvalued" means it's not as useful as
you thought.

 _Either you got a great deal, or you got robbed._

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sfuller
This person probably lives in Seattle.

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gm-conspiracy
Ease of financing?

