ReEconomist

California Signaling A Housing Bottom? [Housing Tracker]

Prices in bubble areas are being pushed down back to their historical
ratio of home price to income ratio. Nationally, the ratio has been home prices are 2-4 times local income levels. This ratio makes sense when you realize that in normal times, sensible lenders will only allow a borrower to use a maximum of 28% of their income for mortgage costs.

For instance, in many bubble areas, the ratio in 1999 was 4 to1.
Home prices were four times income levels.

During the peak of the bubble in 2005-06, median home prices shot up to 9 times median income levels and more in some areas. This was enabled by excessive and temporary purchasing power in the form of exotic mortgage products which enabled borrowers to bid up home prices to unsustainable levels.

Now that lending standards have tightened, is it reasonable to expect a return to the historical ratio? Most think so. What happens to prices? Consider a typical So Cal area where the median income in 1999 was $75,000. At 4-1 the median home price in 1999 was $288,000. In 2005-06 the median home price shot up to $700,000. Meanwhile incomes rose 3% or were $87,000 in 05/06.

At 4-1 prices should be $348,000. Keep in mind, it takes a 4% rise in incomes to allow home prices to rise 1%. (.28 x4 = 1)
There is a nifty tool where you can get historical, bubble and post-bubble home price to income ratios for your zip-code found at UsHousingmeltdown.org. Look for the Ceiling fundamental.