This article below comes from one of my favorite blogs. In this article he talks about three things of importance in pricing a house--1. Purchase of house related to gross annual income (should be no more than 3 times income) 2. Measuring cost of house to what you could rent it for 3. Figuring capitalization rate (related to #2).
From Dr Housing
The housing bubble is alive and well in certain Westside cities. Even as the state in other areas like the Inland Empire has found a more reasonable price level, some areas seem to remain in a state of denial. Prices remain elevated in some markets even though the overall trend is pushing to lower prices. Santa Monica is one of those locations. Definitely a prime Southern California niche but current prices are disconnected from market fundamentals.