Expat

Latest Case-Schiller Report Shows the Sky is Falling

I don't think the estimates make much sense when they are given in a vacuum. "Down 28% from the peak" "Another 10% to go" Blah, blah, blah.

The reality is that the US housing market is massively overpriced as measured against the only thing that matters, affordability. Ignore the wealthy who rarely buy as much as they afford (otherwise, Bill Gates would live in a one hundred million square foot sold silver home).

Median house price is now at $201k (I don't know why this measurement is used, by the way). Median income is about $49k. The long-term affordability ratio for house prices is about 2.8 times income. Consequently, the median house price should revert to about $137k, implying another 30% drop.

What does this 2.8 times income ratio mean? It's not a fantasy number pulled out thin air. It represents the ability of the income to service the loan at typical interest rates and lending conditions. It means you pay one-third of your income on your housing (ALL costs included) in order to remain solvent and save for retirement. It also assumes typical wage growth.

This ratio does not take into account 100% mortgages or option ARMS with teaser rates. It does not take into account the lending backlash as prices collapse (what was loose and easy on the way up becomes tight and restricted on the way down). It is also likely to be a mean-reverting ratio which implies that it needs to go BELOW the long-term average in order to balance out with the insanity on the upside.

Given the insolvency of our major lending institutions, the eradication of irresponsible lending, negative savings rates, widespread debt, record housing inventory, and the recession, we are likely to see the affordability ratio head down towards and below 2.5 times income.

Look out below. The median home price needs to drop to about $120k to signal a bottom.