What is the Fair Value Variable?

Introduction

The Fair Value Variable (FVV) was designed to serve as an adjustment factor for assessing discounts or premiums in the residential real estate market. It relies on national data to estimate a value that reflects whether residential real estate in the United States is undervalued or overvalued.

While the FVV can offer valuable insights, it has a nationalistic scope and may not adequately consider regional variations in the real estate market. For instance, when comparing the percent change between January 2020 and August 2023, residential real estate in Miami experienced higher appreciation than that in Milwaukee.

Calculation

Variables

The variables used to calculate the FVV are as follows:

• Median household income
• Median sales price of houses sold
• Mortgage interest rate

Assumptions

The assumption underlying the Fair Value Variable (FVV) is that a significant portion of Americans engaging in residential real estate transactions opt for a 30-year fixed-rate mortgage. While this mortgage structure may not be universally applicable, it serves as a foundational reference point for gauging the median cost of a mortgage.

Methodology

To calculate the FVV:

1. Determine the median household income spent on annual mortgage payments
2. Use the prevailing mortgage interest rate and median sales price to compute the median mortgage payment
3. Annualize this amount and divide it by the median household income
4. Introduce rolling averages (5-year, 10-year, and 15-year)
5. Calculate the average of these averages
6. Compare this averaged value against the current period
7. Assess the premium or discount needed to align with current conditions

Historical Perspective

The FVV is a real measure rather than nominal, as it accounts for inflation when considering the variables in its calculation.

Notable Historical Figures

• November 1981: Highest recorded percentage (53.5%) of median household income spent on annual mortgage payments
• December 1984 - October 2022: Consistently below 40%
• 2010-2019: Average value was 23%
• November 2023: Rose to 39.9% (73.5% increase in housing costs)

Historical FVV Values

• October 1981: -46.1%
• May 1980: -47%
• June 2006 (Great Recession): -13.5%
• November 2023: -36.7%

Conclusion

The Fair Value Variable (FVV) serves as a crucial tool for evaluating the relative affordability of residential real estate in the United States. By incorporating key variables such as median household income, median sales prices, and mortgage interest rates, the FVV offers insights into whether the housing market is experiencing overvaluation or undervaluation. The emphasis on a 30-year fixed-rate mortgage as a reference point adds a practical dimension to the calculation, despite potential regional variations.