How much is a house worth? Of course prices change over time, but there should be a standard formula for determining the value of a home. It turns out that like anything else, it’s related to the benefits that come with it. The house itself is not the largest factor, or even the most important factor in price. To a large degree, it’s related to availability of jobs. People will move to where there are good paying jobs. Their income determines how much house they can afford. Even within a metropolitan area, homes with shorter commutes to employment centers command higher prices. Logically, there should be a way to calculate a home’s value based on its location. Economists have developed such a formula, and determined that prices do tend to move in the direction of the realistic value over time.

If this is true, we should be able to do the math and go out and buy a home for its actual value? Right? Um, 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 increase in demand drove prices up above the realistic values. 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.

The market correction was necessary, but as often happens, 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 foreclosures and distressed properties drove prices below their correct values.Now buyers are waiting until they’re sure that prices have hit the bottom. But when will that be?

Time and time again, history shows us that the market will overcorrect. The same way that excessive optimism pushed prices too high, fear will push them too far down. When will the decline stop? A few savvy buyers will realize that the prices can’t go much lower, and they 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. Once it starts, then more buyers will join in and the prices will start increasing. Most would-be buyers won’t know that’s happened until months later.

Economists are saying that homes are undervalued in many markets. Which markets, you ask? The markets that grew far above their correct values are now suffering the greatest decreases. 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.

So, should you go buy a house in San Diego?Well, it depends.  Even within a geographic market, the situation is different in various market segments. Currently there are still a lot of foreclosure properties on the market, mostly starter homes. Meanwhile, move up and higher end homes are in short supply. If you’re in the market for a starter home, you might want to wait a bit.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.