What Should Today's Median Housing Price Be?

I was reading a post on Toro's blog regarding Ben Stein v Goldman (fun stuff!), and I came across a very interesting chart which is simply the historical ratio of median housing value vs median household income.

As you can see from the mid/late 1970s to 2001/2002 the ratio was consistent in a tight range between 2.6x to 3.0x. Essentially this means the median home price in this country was 2.6x - 3.0x median household income. And it's been right around 2.8x for most of that time. That's 30 years....

Then in 2002+, we had innovation.... great innovation... and 1% interest rates. Easy money. No mortgage regulation. Happy times. And crazy housing prices that detached from reality. In 2006 at the height of 'innovation' (where were these politicians one year ago? seriously), the ratio went "off" the chart, it appears 4.0x. After the 'correction' we've had, that ratio has fallen all the way to.... 3.8x.

What bugs me most about the 'plans' the politicians are doing is this will only slow down (to some degree) the inevitable - prices coming to a point average Americans can afford. Well I should not say that bugs me the most - all of these bailout plans "points" bug me the most. But this is one that the politicians don't get. Once again they sacrifice the long term for short term. As with everything. (I will spare you the soap box for the 100th time)

But let's take a back of the envelope analysis and see where housing prices really need to fall before they make sense with historical ratios.

In July 2006, at the height of insanity, the median price of a home was $230,200
It has already fallen in less than a year (October 2006) to $207,800

Pain over, correction done - time to party. Right? Wrong.

What are median incomes nowadays? As of 2006 the median household income was $48,201.

$48,201 x 2.8 ratio (historical average for past 30 years) = $134,962

Folks that is still nearly $73K away.... or a drop of 35% from October 2007 levels. And a drop of 41% from peak levels in July 2006.

Correction over? Not by a long shot.

Now that's assuming we return to historical norms. I am fully confident that by the time this is all said and done, new financial innovations will be introduced (along with bailouts) which will keep prices elevated above where they 'should be' without the 'not so invisible hand' propping things up.

So let's assume household income rises 4% each year (I would argue this is generous considering wage pressure coming as corporations see profits drop.)
And let's assume inflation is imaginary (I mean, it works for the government) and we are not paying 5-12% more for food, energy, et al and that does not stress people's budgets - so therefore all this 4% yearly gain in income will be diverted to buying homes and not paying for necessities of life.

Then in 2008 median incomes will have risen to $52,134
And let's assume instead of returning to the 2.8 ratio that is historically where median house values vs income falls, but instead we can now subsist at say 3.2x because of 'the invisible hand', this takes us to

2008: $52,134 x 3.2 ratio = $166,829

That's still a $40,971 drop in median pricing or just under 20% from today's levels.

And again the above assumes we don't return to historical norms.... and we have no inflation, and we have no pressure on household incomes from growing credit card debt, and we don't go into recession, and people don't start losing jobs, and ... and... and...

Well you get the picture. 20% drops should be expected at a minimum. 35% would be expected if all was fair in love and war. But I truly think the plan is to get interest rates on mortgages back into the 5% world on fixed, and some ungodly low number in adjustables so we can repeat this mess all over again in a few years. All these bailouts and freezes again miss the main point - homes in major urban areas are not affordable under traditional mortgages to real people with real jobs and not in the upper 5%.

Due to inflated pricing (that politicians want to protect) people are forced to pay 40%, 45%, 50% of their income just for a roof over their heads. So by "helping them" you are "destroying them". Slowly but surely. But anyhow, that's small stuff - we have banks to bail out.... that's the important thing.

Welcome to the jungle.

Comments

[Analytica]

Right on! This is consistent with Shiller's analysis. See

<www2.standardandpoors....;

and

<timeblog.com/curious_c...;

Housing prices are on the decline and will reach historical norms in the next 2 years.

Price declines make the government negotiated re-set freeze program moot. One of the requirements is that the property value cannot have dropped since the original mortgage was created.

[Scorpio69er]

Months ago, in response to an article on Salon, I posted this:

"Any attempt to allow troubled homeowners/speculators to re-fi using government money is doomed to failure, becuase it ignores the simple fact that present prices are totally out of whack. This is even more true now that lending standards for would-be homeowners are tightening, returning to traditional requirements for down payments, income-to-debt ratios, etc. A return to traditional lending standards neccessarily means a return to traditional pricing. Thus, even if people can manage not to default on their home loans, they still will never be able to sell their place at today's artificially inflated prices because no one can qualify to buy it, nor will the source of lending that pumped prices up to the current level any longer be there."

[CM]

I live in San Jose, CA and the housing prices here are about 100% overvalued (typically 1,400,000 for a living home and area)... A 20-25% drop would leave the prices as still heavily overvalued. From all the places I've visited around the country, 35-50% would seem more reasonable to place housing prices on par with the long term trend. Several areas went up 40% the last year, so a 20% drop is not very noticable.

[slk23]

Good analysis.

The price of money seems to be the main factor in home prices, at least from what I can see. Prices rise or fall to levels that reflect how much people are willing to put into monthly mortgage payments. Low interest rates = high home prices. Exotic mortgages distort the relationship since they are based on short time frames.

[Malkiel]

"homes in major urban areas are not affordable under traditional mortgages to real people with real jobs and not in the upper 5%."

But that's actually always been true. In urban areas I'm familiar with like Boston and New York, ordinary people rent within the urban center or commute from affordable outlying suburbs if they want to own. The high-paycheck MBA's and executives do all the owning within the urban center. That much was a social fact well before this bubble and probably won't change after it's over...

[TraderMark]

But in the past 3 years its spread to San Diego, Portland, Seattle, Phoenix, (parts of) major Florida cities, Washington DC (all of northern VA) etc. I do agree NYC and San Fran for example have been and will always be, but in NYC even "they" are saying all middle class are being driven out of certain boroughs (i.e. Manhattan) so its even becoming more stark of a 'separation'. I do agree cities with "limited" land expansion should face such a situation but those that do not, it doesn't make much sense (i.e. Phoenix? Las Vegas?)

[ReadThisYouBuffoons]

Get a grip, doomsday-mongers -- analysis is flawed! See post below from a blogger that skewers Toro's shoddy analysis.

++++++++++++++++++++++...

Toro, I did an analysis of where prices should be if we allow (by we I mean the gov't) prices to fall where they historically would be versus incomes - answer = $135K in 2006. Vs the $206K

Full analysis:
www.fundmymutualfund.c...

Posted by: TraderMark | December 06, 2007 at 12:17 PM

One flaw in your analysis is you compared June versus October in a market that has a well-known seasonality to it. Another flaw is that it is useless to compare median prices anyway, since they only show the prices of houses that have "changed hands" - this is an especially big problem now that sales volume has dried up, because the less liquid a market is, the less efficient it is and the less believable it's pricing over short periods of time. One final point: when comparing "drawdowns" in housing equity, it is important to look at inflation-adjusted changes rather than nominal, especially when comparing an inflationary period (today) with a deflationary one (the depression). A very likely scenario for the US housing market "bust" is a prolonged period of slow nominal declines accompanied by inflation, thus deflating the bubble in real terms without ever generating headlines regarding a 15% "crash".

Posted by: Doug | December 09, 2007 at 08:10 PM

Interesting... he seemed to have a decent grasp on the situation in 1984:

query.nytimes.com/gst/...

Posted by: JeffM | December 11, 2007 at 12:49 AM

[Adfecto]

Your analysis has merit but I have a couple issues I'd like to raise. I see a factor which makes your calculations a little more extreme than reality. You are comparing apples to oranges by comparing the median home price to the median income. Not everyone buys a home. Home owners have historically had higher incomes that those that rent, so a more accurate ratio would be to compare the <b>median income of home owners</b> to the median home price. That ratio is a better metric to see excessive inflation in housing prices. It is misleading to assume the median income must be able to afford the median home price. There will always be people who are priced out of the market. You must also recognize that in recent years income inequality has increased so that the median is a less and less a realistic or useful measure of incomes for home buyers. The disproportionate wealth of the 'haves' allows them to bid up home prices in desirable coastal areas and will continue to do so in the future. Foreign buyers will also prop up the inflated home values increasingly because of the weak dollar and desirability of a US second home.

blog.aspire2wealth.net

[Sanibel]

I don't agree with this analysis. It does not factor in the level of long term mortgage rates. For example, under the analysis adopted here if long term mortgage rates droped to 1 percent or they rose to 12 percent, the outcome would be the same -- the current market is over valued. (Yes, I realize long term mortage rates won't go to one percent and are not likely to go to twelve percent any time soon). In other words comparing houseing prices to income does not tell us all of the necessary information. Housing purchases are leveraged investments. The lower the unit cost (ie. the montly mortage payment) the more you can buy assuming a constant total income.

[TraderMark]

I would argue that many who bought in 2004-2006 in high cost urban areas, would not be able to afford their homes in the long run at 0% interest.