Q: What Are Bend Homes Worth? A: $185,000.

We got the CNN-Money list of most overvalued & undervalued metro areas in the country, issued June 16. Bend is at the top of the list, with a stated overvaluation of 78.7%. First, if the median they used of $324,400 is accurate, we are more overvalued than that. Our median now stands at $351,900. Given the figures in the article, you can back out $181,533 as "fair value" for Bend, or 93.8% overvalued. An excerpt:

Bend took over first place from Naples, Florida, which had led the pack for several years. Price declines in Naples enabled it to slip into third place at 63.4 percent overvalued. In second place was Prescott, Arizona, at 64.6 percent.

So what is the median home worth around here? There's a myriad number of ways to arrive at fair value. Maybe the most relevant, is comparing owning to renting. I ran across an article in this regard wayyy back when the bubble was still in full force across the country. It was by Liz Pulliam Weston, called "Don't get trapped in a housing bubble". An excerpt by economist Edward Leamer:

Leamer says he can tell because homes, just like stocks, have a price-to-earnings ratio (P/E) that he believes determines their fundamental value. The earnings part of the ratio consists of the annual rent the house could command. Homebuyers can compare current P/Es with historical levels, Leamer says, to get some idea of whether houses in their cities are becoming overvalued.

I like the idea of computing the P/E the most, as it's inverse, E/P is the earnings yield for a property, and when you think of a rental home like a earning investment, it's easier to separate out all the nonsense that people sometimes associate with owning a home (I'm thinking specifically of a comment where someone stated, "I don't think Bend could imagine itself without Northwest Crossing". Woof.).

What's hard here, is that Bend does have a very wide range of rental properties. You've got your "Arson Ready" properties: Homes that benefit the entire of humanity when they "accidentally" burn to the ground. Twice. These are barely fit for human habitation. Then there are the brand new McSubdiv homes, with line upon line of cookie-cutter 1,800/sf homes. These are the meat of our market it seems. And there's the NWX whacky-shack, typically owned by a Realtor or mental patient, that bought into the $10K appreciation/mo. line of crap spewed to sell these white elephants. It's really a wide range.

And computing the P/E is a totally different exercise for each. The McArson Meth Lab rental is going to have many expenses not associated with say, a 500/sf NWX dog house rental. "McArson" (aka, "The Mic") rentals will typically have the dog-pee-soaked subfloor, load bearing 32 gallon meth drums, and Kohlers new "River of Pee" septic system, developed exclusively for for India's City of Joy whorehouses, which is basically a small ditch dug in the dirt floor that drains out in the septic field; ie front yard. The Mic is a maintenance nightmare. All this has to be factored into the "P" (Pee?) part of the P/E equation.

Contrast this to the NWX doghouse rental. At 500/sf, buyers usually had to assume second mortgages financed by the local TV station, since about half the value of these homes is advertising. I've long maintained that NWX is the most overpriced neighborhood in Bend, and it is precisely because of this: Rental income there is a small fraction of what a mortgage will run you. Homes that cost $500/sf are fetching $1.25/mo as rentals, or a 3% yearly yield.

Those two example illustrate the gamut of what the rental game is in Bend. The very high maintenance meth-laden crap shack vs the low/no maintenance 6 mortgage NWX special. I think the meth cracker box is an endangered species though: It's just going to pay for someone to "smoke cigarettes around oily rags", and let nature take it's course. Face it, these places are worth more dead than alive.

What Bend is really looking at is a mega-glut of brand new 1,800/sf McSubdiv homes. And these are what are really facing steep price cuts recently. Multi-million dollar mansion? Hell, you just have to find One Guy to buy that dog. Your platted out, 100 lot McSubdiv isn't going to sell in onesies and twosies anymore, you gotta mark 'em down to get'r done. I've seen many of these go from near $400K in Phase I, to $300K or LESS by the end. These love shacks can usually fetch somewhere between $1,100 - 1,400 depending on the time of year and such. Assuming $1,250 and $350K middle of the road estimates, this gives about a P/E of 23, or a 4.3% yield. 2 words: Not Good. 2 more words: Really Good. If you're a renter.

Pulliam's article outlines P/E ratios for a number of big and traditionally overpriced metro areas. Boston, San Diego, Frisco are in the high 20's, with Chicago in the low 20's. Bend's current P/E puts it close to Seattle. Do we really have the economic base to maintain a Seattle-style P/E? You will have to be the judge of that yourself, but my own opinion is that once the Tequila wears off, that Bend's P/E should be in the 13-15 range, and that's assuming rates stay relatively low. A P/E of 14 X $13,200 in yearly rental receipts (with NO other expense, taxes, etc) yields $184,800, remarkably close to CNN Money's estimate.

We've also heard a lot of talk about a "return to normalcy", like it's a good thing. In a way it is, we'll be cost competitive in many ways that we aren't today. I found an OFHEO Housing Price Index that showed Bends long-term, non-bubble yearly return to be about 7%. This is actually higher than I thought it'd be. The index starts way back in 1986, so it is a very large sample, but the standard deviation is also large at around 7%. All that means is that we can state with very high statistical confidence that Bend's mean yearly return is between 21% and -7%... no help there. You can maybe safely assume that Bend has had some sort of persistent long-term appreciation premium due to 1) Excessively depressed performance right before the sample period, or 2) Bend has enjoyed some sort of excessive in-bound "migration premium". during the period., or 3) There is some sort of constraint that is holding up prices during the period. Or maybe something else. Is 7% a rational appreciation rate going forward? I don't think so.

Bend has experienced 2 very high yielding periods in the past 20 years, one in the early 90's and the recent huge gains. Taking out these periods, Bends has experienced fairly ordinary gains, something closer to 4-5%. I think something around 5%, maybe 6%, is what Bend should experience over the long haul, maybe a bit over the 1% real return that Robert Schiller puts forth as the long term gain for US housing in aggregate.

Second, homes act much like bonds or other "yield" type investments. As rates decline, their price goes up. But as rates decline, the forward looking return goes DOWN. You get appreciation as rates decline, but less yield going forward. We've had our appreciation run, in spades, now I think it's all been squeezed out (and then some), and we have nothing but the poor yields to look forward to.

So, I would put forth that Bends very long term 50 year appreciation rate, from 1986 should be around 5%. Using the OFHEO data to back out an approximation of 1986 home prices (a very faulty exercise.. someone tell me if you've got better data...), we "de-compound" at 7% for 20 years, use $351,900 as our starting point, and arrive at a (very) rough starting point of $91,000 in 1986. I can't overstate how rough this number could be, I don't know what 1986 medians were. The good news: Compounding forward 50 years to the year 2036, gives a pretty rockin' median of $1.04MM. Not bad! That's up 195% from here. The bad news: It'll take 30 years or so to get there. That's only 3.67% per year yield, buying today.

Where does this metric leave us today as far as fair value? Well, compounding forward from 1986 @ 5% for 21 years gives about $250K as fair value. 4% for the period gives $207K. So the whole "return to normalcy" also yields lower prices, but not as bad as CNN-Money. This methodology is sort of a least-squares projection forward of logarithmic-adjusted data, starting in 1986. Well, close. It's just hard to take the data as given and come to mathematically solid start or end points. So this method seems less accurate than P/E's, though not totally discountable.

What about replacement cost? Hmmm... this may dictate whether new homes are being built more than anything, because I think precious few home buyers of older homes care what aggregate, timber, stone or other materials cost at the time of construction were. It seems to be something that becomes less and less relevant with time. But Bend is becoming a "new town"; our installed base of homes probably has a lower average age than it did 10 years ago. Schiller actually shows an HPI index with material cost indicies on his Irrational Exuberance website. This data is fairly interesting in it's own right, and I encourage anyone interested to download the Excel/CSV data file Schiller has made available.

Building material costs ARE relevant, but mostly in the determination of the "build or buy" arbitrage equation: Should you buy your neighbors farm, or build next door? This is one of those things that can swing wildly year to year. I think there was a time in the past few years where timber prices doubled, before falling back. I think more interesting than raw materials prices, are the wage rates in the construction industry in Cent OR. I saw on the front page of the Oregonian yesterday an article about the percentage of illegal immigrants in various industries. Cooks, landscaping, construction, and housekeeping were the top industries penetrated by illegals. Political swag aside, these are the bread & butter of Cent OR's economy. These people are the Yugo's to our whitebread Camry past. They'll do it, and they'll do it cheaper. I think from this trend alone, home prices will come down (if immigration bills stay encumbered), and Bend will become more "slum-like". Not a slam, but just true from observation. Mexicans have no qualms about living 10-15 to a home, and will to economize their earnings. Their wages & economic "limbo" pretty much force this on them. I think Cent OR's percentage of Hispanics and other ethnic groups will increase, and they will start to become the "middle class". And call me crazy, but there could be a pernicious little trend of turning today's new McSubdiv homes to McArson Meth shacks over the years.

Maybe this is a little too political for figuring out "Fair Value" around here, but strong Hispanic immigration, especially the illegal variety, can have nothing but depressive effects of wage rates. Boss Hog certainly benefits, since he'll have Chico manning the stoves, weed whackers, nail guns, and the like instead of Johnny Whitebread. This will lead to a gutting of the middle class, and something like a vast servant class (Morlocks) serving a tiny elite group (Eloi). This seems to be the trend countrywide and Worldwide in fact. This country seems to be morphing into a culture that fewer and fewer are able to economically adapt to, and extract some semblance of what many think of as a "normal life". We're looking at the first generation of 30-somethings with lower standards of living than their fathers. Whitey ain't competitive, and I don't know if you've looked around recently, but there's a hell of a lot of us in Bend. Demographics seem to favor lower prices.

Finally, there's the "Bend is different, and people WANT to live here." There were some disparaging comments about no one wants to live in Wichita or some such on the last thread. Well, first Wichita isn't a real fair comparison, just like Fargo isn't. It's the Midwest, and it's different. This whole attitude presumes that geography and outdoor activities are All That Matters. Bull Poopy. They're a nice plus, but they are secondary to the business of living. Assuming Bend is a destination for all because it's a destination for you simply tells us they speaker is so blindly selfish, they can't see beyond their own nose. If I could double my earnings in Wichita, and cut my home price to the median ($99,100!), I'd be there in a heartbeat. I'd sacrifice some sort of quality of life today, to save like crazy and retire early tomorrow. This is yet another nail in the coffin of Bend home appreciation. People will not become indentured slaves to a lifestyle that requires 90 hour workweeks.

In conclusion, the yield of Bend rentals is the most appropriate measure of valuation, as it measures the "comp" of rent vs buy. It shows a fair value of around $180K. Other less measures of value, but nonetheless indicative of possible future trends also seem negative. Future supply in the guise of chameleon-like destination resorts bode terribly for the future. I think backward-looking ROI computations will on marginal ("half-assed") large scale projects (Redmond Water Park, The Shire, The Plaza, Angus Acres, Work-Live condos, "Expensive" office space) will act as nothing but massive depressants on our market for many years. We're building enough supply today for the next 20 years. Bend housing will be a mini-S&L crisis. We'll become a town largely comprised of Hispanics and there will be a certain Mexicanization of Bend, which is well under way. There are opportunities there, but they'll probably be capitalized on by Hispanics.

On the upside, Bend is a great place to enjoy the outdoors... if you can afford to. The weather is nice, the mountains & diverse geography, and all are terribly fun. But there's less and less "fun" time for the median person living here, and so this aspect of Bend becomes less & less important.

The Bottom Line: Bends Fair Value Median is $185,000.

This is kinder than CNN-Moneys implied fair value of $181, 533, but not much. The obvious bad news is it's a 47% haircut from todays prices. Some think we'll see such a nominal decline in short order. I do not. Housing prices have traditionally adjusted very slowly, and much in the way of "losses" in falling markets have been in prices treading water for years (decades), not really falling much. I think we'll see a combination: prices falling slightly, then rising slightly, then falling again... for probably 20 years or more. I think the target date for todays prices being equal to "fair market value" is about 11 years from now. There may be some particularly terrible intervening price plunges that'll give someone abnormally good returns in the meantime, but they probably won't be for sometime, 10 years minimum.

Not to beat a dead horse, but if you're planning on living in Bend for the long haul: Rent, and Invest The Difference. Cater to the extremely rich or Mexicans. Own landscaping, hotels, restaurants, don't work there. Or do what really makes sense:

LEAVE.