No magic answers here. Housing is a market, and the conditions in each local market vary.
I think impact on cash flow is the best way to evaluate housing prices. In general, I consider a "cheap" home to cost 20% or less of your income, "affordable" between 20-30% and "not affordable" over 30%.
When you start comparing rent vs. buy, there are other factors that you need to think about:
- Is it a tight rental market? Easiest way to tell this is to compare the costs of ghetto apartments to nice apartments. Government housing subsidies are based on prevailing rent, so when a two-bedroom in the hood is over $1,200, you have a hint that rents are high in the area.
- Is it a tight home market? Do sellers expect written offers within hours of you looking at the house? If so, you are paying too much.
- What landmines are out there in terms of risk as a homeowner? Is the city and county well-run in general? Is there a large police and paid fire department? Do the schools suck? Is the local government on a bonded public works building spree?
- Are you dependent on an HOA to provide basic services? (Sewer, water, etc) Are you willing to participate in the HOA and argue with people?
- What are your income prospects for growth and stability? Are you a construction worker on unemployment during the winter? Do you have a moderate pay/low risk government job? Are you a salesman?
Renting is an easy transaction. You're comparing prices in a market that is usually pretty stable, and your risk and liability is low. The "cost" of the low risk is that you have virtually no prospects of recouping any value out of the cash that you are laying out for your home.
Buying is more complex. You're buying a house, building equity and probably making money due to appreciation. You need to be vigilant about expenses and circumstances that affect the value of your home as an investment. If you live in a high-tax state like New York, an extra $1,200 in property taxes saps over $16,000 of buying (borrowing) power from a future purchaser of your home. If your HOA or condo association is run by a pack of idiots, you're going to end up paying through the nose for their mistakes.
Another consideration is your tastes. If you tend to live above your means, you're not going to be able to afford necessary maintenance on the house that you paid too much for.