What’s the value of a home? Of course prices change over time, but there should be a standard formula for determining the value of a home. Like anything else, it’s determined by the benefits its owner receives. It’s not just about the house itself, or homes in New York wouldn’t be worth so much more than homes in Idaho. To a large degree, it’s related to availability of jobs. People will buy homes near good paying jobs. Their income determines what payments they can qualify for. Even within a metropolitan area, homes near employment centers are worth more than those in outlying areas. Logically, there should be a way to calculate a home’s value based on its location. There are such models, and they tell us that prices tend to move in the direction of this value over time.

So we should be able to figure out the actual value and buy a home for that price? Right? Well, no. In the short term prices fluctuate according to other factors, such as lending practices and consumer optimism.A few years ago lenders were making a lot of subprime loans. Anyone who could qualify at the teaser rate based on stated income could buy a house. The increased demand drove prices up to unrealistic levels. No one worried about what would happen when the rate increased. They assumed that prices would continue to rise and mortgage financing would be available. But of course artificially inflated prices can’t last forever. When mortgage payments on those subprime loans increased, it all started crashing down.

A market correction was definitely in order, but as we often see, it went too far. Lenders didn’t just stop lending to buyers who can’t afford the payments. They made the requirements so stringent that even buyers who could qualify during ‘normal’ times couldn’t get a loan.And a flood of distressed properties and forclosures drove prices well below their values.Now buyers are waiting until they’re sure that prices have hit the bottom. But when will that be?

As before, market prices will overcorrect. Just as optimism and easy lending drove prices too high, fear will drive prices too low. When will the decline stop? A few smart buyers won’t be able to resist the bargains any longer.  If you can buy something for less than it’s worth, you come out ahead – even if someone else gets the same thing for a dollar less the next day. As soon as it starts, many home buyers will jump on the bandwagon and prices will increase. Most would-be buyers won’t know that’s happened until months later.

Economists are starting to tell us that residential real estate is undervalued in many, but not all, cities. Which areas, you ask? The areas that saw unrealistically huge price increases are now suffering the largest declines. In a review of Southern California real estate prices, Global Insight said that real estate in Los Angeles is 6.4% undervalued, Orange County real estate is 10.9% undervalued, homes in Riverside-San Bernardino are 15.7% undervalued, and San Diego homes are 21.2% undervalued.

Does that mean you should rush out and buy a home in San Diego or Riverside?  It depends.  Even within a geographic market, the situation is different in various market segments. There are still a lot of distressed properties and foreclosures on the market, mostly starter homes. At the same time, higher end homes are relatively scarce. If you’re looking for a starter home, now might not be the right time.If you’re looking for a larger home, there are some deals available.And right now the government is offering tax incentives to home buyers in an effort to get the real estate market moving again and interest rates are at historic lows.