Tuesday, August 19, 2008

House Prices & Household Income

Seems like folks out there are all aflutter over declining house prices (rapidly becoming a serious problem in the industrial world). A huge bubble was blown as reflected in the parabolic increase in mortgage debt over the last decade (peaking in 2007).

One question that came up yesterday while I was lurking in some of my favorite blog haunts (the automatic earth) is how much house prices will decline before "hitting bottom" -- like a drunk in need of AA I suppose. One number that appears in the media from time to time is 30%, others predict a 50% decline in median house prices from their peak in 2006-2007. Others are obviously more pessimistic. According to the LA Times this morning ("Southern California home sales jump..."), the decline in median home price for the region is well above 30% from its peak.

It seems that the attempt to predict the severity of the fall in home prices nationally stems from the historical analysis of home prices relative to household income. Makes sense -- as nominal or real incomes have increased, they should roughly keep pace with the prices of homes (unless people, on average, like to pay a greater percent of their income on mortgages and property tax). Or so the logic goes.

One frustrating thing for me was that I didn't have any numbers myself to see the historical trends and how much the recent run up in prices breaks recent historical trends. So, I dug up some data and made some graphs for a visual analysis. I found some nominal and real house price data at housingbubble.jparsons.net. Then got some historical household income data over at the good ol' US Dept. of the Census. I put these data together into the following graphs.

So what do we see in this first image? Two points:
  1. Both median house prices (light blue) and median income (dark green) increased throughout the period in nominal terms (i.e., not adjusted for price inflation). Moreover, starting in the late 1990's, the median house price went positively parabolic, peaking in 2006. Median household income did not make a similar move.
  2. When house prices and median household incomes are adjusted for price inflation (dark blue and light green lines), the median house price becomes flatter over time, with more obvious boom-bust cycles. There is also less real growth in median household incomes over this 32 year period with a modest decline and recover in real terms during the 2001-2006 period -- the period that house prices clearly go "off the reservation".
So, the pattern in the first graph left me wondering... Was the ratio of median house prices and median incomes more or less constant during the 25 years between 1975 and 2000? Also, how much did the ratio change during the historical anomaly between 2001-2007? Here's another graph showing the ration between (nominal) median house price and median income.

Well, two things are pretty clear in this picture:
  1. The ratio between house price and median income pretty much stayed around 3:1 during the first 25 years of this period. The ratio went up a bit above 3:1 during real-estate booms, and fell a bit below 3:1 during the bust.
  2. The ratio climbed to just over 5:1 in 2005-2006, a 66% increase!
So, how do these data help us decide what will happen to house prices nationally? Well, if median household incomes hold up (in 2006 dollars), prices would need to come down about 50% to return to the 3:1 ratio that had been the historical norm for the 25 years or more that preceded the current housing price bubble. Of course, since we are at the start of a very nasty recession (the result of the unwinding of all the credit generated by this housing bubble and other associated bubbles generated during the same period), the likelihood of the median income holding at 1996 levels aren't so good. So, there may be a race to the bottom that way overshoots the 50% decline. And that ain't even considerin' the massive oversupply of housing that was built up during this same 10 year period (1997-2007).

I guess we should all hold on to our seats, it's going to be a humdinger of a ride these next few years!

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