What Home Prices Should Be?

Sammy sends me a link to this at HomeGuide123:

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.

A graph follows, which doesn’t copy easily into blogger, but this is the data in it:

U.S. Median Home Prices

Current Median*: $208,400
What the Median Should Be: $134,692
% Difference: 35%

They also show the same information by region… and also one other thing:

California Median Home Prices

Current Median*: $402,000
What the Median Should Be: $158,606
% Difference: 61%

I haven’t checked through their figures but I assume they’re about right. Also, I’m not sure that a ratio (2.8x in this case) should hold forever. I would prefer if this is was true (being a non-owner at this time) and I kind of believe it. But sometimes there are structural changes. A longer mortgage, or much improved tax advantages of owning relative to renting (or borrowing relative to not borrowing) might change that expected ratio. Other things that might do it: laws limiting the amount of new homes that can be built, the likelihood that salaries will be shooting through the roof, or a good chance of very, very high inflation in the future. (In the latter case, you can take on a lot of debt, because a lot of debt will soon become a little debt.)

Now, I don’t think we actually had one of those structural changes. I do think for a while it looked like we had a structural change along a few different lines:

1. In the mid-90s (when home prices began rising, especially in California) people’s incomes were rising very rapidly.
2. In the 00s, interest rates were kept very low.
3. New debt instruments with somewhat magical properties appeared.

Item 1 disappeared around 01, but it was replaced by item 2. Item 2 is still around but it seems to have much less effect now, especially after many people’s real incomes have been essentially stagnant for several years. Item 3 is disappearing as the magical properties of the new debt instruments were shown to constitute a mix of fraud and ignorance.

The only thing I can see added in is foreigners deciding that the next few years are a fine time to pick up Malibu beach front as there’s only so much of it. But I don’t see that as being quite so big of an effect. So unless there’s something missing, 2.8x seems as reasonable, in principle, as anything else. But man, its hard to see that kind of a drop.

Your comments?