What Median Home Prices Would Look Like If the Bubble Never Happened
How much should you be paying for a home? The answer is easy to calculate if you understand the connection between median home prices and median incomes.
Historically, median home prices and median incomes have always shared a close relationship. From the mid-1970s to 2001, the historical ratio of median housing value vs. median household income was consistently between 2.6 and 3.0.
What this essentially means is that median home prices were (on average) 2.8x the median household income for the last 30 years. Using this 2.8 formula, it is very easy to estimate what median home prices would be if the most recent bubble never happened.
Median Home Prices by Region
| Region | Current Median* | What the Median Should Be | % Difference |
|---|---|---|---|
| Northeast | $258,600 | $145,760 | 44% |
| Midwest | $159,800 | $133,941 | 16% |
| South | $173,400 | $122,875 | 29% |
| West | $309,800 | $146,297 | 53% |
Using the 2.8 formula, it is clear that local bubbles aren't the problem. Median home prices are inflated in every U.S. region. In the West, where the median household income is $52,249, median home prices are more than double what they should be. The situation is similar in the Northeast, where the median household income is $52,057.
Median home prices are not quite as high in the South and the Midwest, where median household incomes are $43,884 and $47,836 respectively. Even so, prices are still 30 percent higher than what they should be in the South and 16 percent higher than what they should be in the Midwest.
California Median Home Prices
| Current Median* | What the Median Should Be | % Difference |
|---|---|---|
| $402,000 | $158,606 | 61% |
The result is that home prices are 61 percent higher than they should be given California's media household income of $56,645. In some areas of the state, such as San Francisco and Oakland, median home prices are so inflated that they are more than 11 times the median household income.
10 comments:
You are absolutely right.Government is trying to prevent the fall. But home price, especially in CA, should fall back to the reality. And it is actually good for the economy if it really happens.
I have to wonder if it will be to median income though. I wonder how much low interest rates through of this statistic, dinks, good schools, large families living to one house, building permit fees etc. All the same I am hopefully for 4 times median income. From the listings I am seeing right now in the areas I am intersted in another drop of 100000 should put many back into the prospect category.
Very nice.
That said, I would add one comment. The issue isn't really completely one of propping up prices. It's more an issue of who is going to pay for the all the bad debt. The financial corporations don't want to do it and the government might, if it thinks it can get away with it. All of which is to say that the two parties left holding the bag won't be the government and regulatory agencies who screwed the pooch of the financial companies that greeded themselves into a ton of debt. It will, eventually, be us, the taxpayers. It's just a matter of when and how, not if.
Great job as usual, X! I predict the next bubble will be the page hits your blog gets as this really intensifies this spring. Keep up the good work. As the five stages of dealing with the truth go from denial to anger, followed by bargaining, depression, and finally acceptance, I believe the I.E is in the final stage of bargaining, with depression nigh upon us. Keep the popcorn poppin', the slow-moving train is desperately trying to avoid the inevitable horrific crash! We ain't seen nuthin' yet! All the king's horses and all the king's BENS (bernanke, of course) cannot put humpty "bubbly" dumpty back together again.
Thanks for the article, but I won't use the past to say what the future should be. Personally, I would use the "affordability equation" to calculate what the median price should be. For example, median income for an area is $50,000 and with a healthy house expense of 35%, one could afford a monthly payment totaling $1,458. This monthy payment includes mortgage, insurance and property tax. Assuming the actual monthly mortgage payment is $1,000, then the median price should come out to be $220,153 with a 20% down payment and a 5.5%/30 years loan.
Thanks so much for posting this. My husband and I have been wanting to buy our first home, yet the numbers just don't add up (even if we had just a car payment and no other debt)! It is mind boggling that people bought these homes even though it's obvious that they couldn't afford one. So here we are, a nation in debt. Well, now I feel even more strongly that we should wait, though I don't think prices will go back to appropriate ratios.
Prices will eventually go back to the traditional ratios. Whether that happens quickly due to a price decline or slowly due to a combination of price declines and then stagnation while inflation catches up is anyones guess. I don't think the prices will decline to hit the ratio all at once. I think the prices will decline about 50% from peak and then a long period of flat prices will allow incomes to catch up. This will eventually get us back in line with the traditional income/price curve.
Thanks for sharing your vast knowledge with all of us. One question - I understand the median home price should fall, but what exactly are people proposing to buy if the median home price is to fall to sub-200k levels? A small one bdrm condo somewhere in Banning? Single family homes in well-established neighborhoods tend to fare better than condos and I don't see these particular homes going down with the ship as much.
If past is preview, patience will be rewarded. I recall sitting in a similar seat in the early '90s, waiting to buy my first home. At that time, an analyst from Prudential Securities produced a report that showed CA home prices should revert to 120% of the national average (they'd spiked to 210% or so in 1989). Prices never quite dropped as much as I'd hoped, especially in the coastal market where I eventually bought.
A criticism I have for some of the current analysis is that it is lumping markets with widely divergent outlooks and dynamics. For example, the LA County MSA includes both Palmdale/Lancaster and Manhattan Beach. I'd argue that there is no relationship between prices in those markets. Manhattan Beach prices will be driven by the income of the top 10% or so of households in LA County. Prices in Palmdale, however, should bounce around construction costs (+/- $80/sf).
Also, keep in mind that in Southern California, over 50% of the households rent. That means that prices should be related to the median of the top 50% of households (+/- 75th percentile), not the median of the whole population.
You don't need to move to Banning to get a decent home for under $200k. There are already decent homes in Moreno Valley, Perris, Lake Elsinore, Murrieta etc. for under $200k. Heck for $250 you can get a nearly new McMansion in some of those cities. Yes, they might be a little out of the way but the price declines are moving outward like a ripple in a pond. They will eventually work into the more desirable areas. More established areas hold up better because the turn over is low. People in those areas probably bought pre-bubble and are not flippers, speculators or upside down on the mortgage. But those areas will eventually decline because people will just not buy the homes if they can go down the street and get one for $100k less.
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