Malcolm Gladwell wrote a really good piece on Grantland about how the psychic benefits of owning an NBA team convince team owners to pay significantly more to own a team than the assets and revenues justify:
http://www.grantland.com/story/_/id/6874079/psychic-benefits-nba-lockout
It got me thinking about how this principle applies to real estate. From a purely economic view point, the value of a piece of property is the present value of the discounted cash flow from the rental income you can generate from the property.
From a simplistic view point, if your monthly rent exactly covers your payments for principal, interest, taxes, insurance, and any home owners' fees, the size of your mortgage is about the market value of the home.
Very few properties meet this test though. When friends express their concerns about wanting to buy property they are worried about it losing value, I suggest they look for properties that they could cover their costs as a rental if they needed to move out. They reply that they can't find anything near that price where they want to live.
Evidently, there are psychic benefits to owning real estate as well that increase the prices well beyond their discounted cash flow. There is a certain prestige associated with living in certain areas. The joy of a short commute or a good school system come into play. However, when you are buying investment property forget the psychic benefits. Focus on the numbers. If they make sense economically you will reduce your risk and you won't worry about the fluctuations in the psychic value of your property.
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