U.S. Housing: The Big Picture by the Numbers

by: Carl Dincesen March 27, 2008 | about stocks: IYR / SPY / XHB    

Carl Dincesen

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There is no denying that all real estate is local and that over the long term, personal income ultimately drives the price of residential real estate. As shown on Chart 1, residential real estate price bubbles in 1989-90 and 2006 where periods when the growth of home price values in the Northeast and West have substantially exceeded the corresponding growth in personal income.

Chart 1 displays the difference between the cumulative percentage change in the median price of new single family homes sold and the change in per capita personal income since 1976 for each US Census Bureau Region. Using 1963 as the base year (not shown) the Chart shows the same obvious correlation of home values to personal income. Since both price and income are on an unadjusted, nominal basis, they are eminently comparable.

click to enlarge

Personal income driven normal home value growth in the South Region, excluding Florida, has masked the Florida price bubble that occurred in its costal communities. In many ways, Florida has less in common with other States in the South Region, which includes Texas, than do the contiguous States comprising the other three Regions. Declining prices in the Mid West follow declining personal income.

Chart 2, displays the price bubbles in the Northeast and West Regions with per capita personal income growth applicable to those Regions. The gap between home price and personal income appreciation (the Gap Ratio) at year end 2007 was 20% in the Northeast Region and 36% in the West Region, or as ratios, 1.20x and 1.36x, respectively.

In 1989-90, the Gap Ratio was 1.21% in the Northeast and 1.14% in the West. Mortgage interest rates were in the double digits and mortgage underwriting standards were high, 20% down payments were the norm and variable rate mortgages were widely available. It appears that price bubbles just happen from time to time as they do in all markets.

What happened to new single family home prices following the 1989-90 bubble?

Following the 1990 West peak, new single family median home value dropped by 11.2% over two years resulting in a Gap Ratio of 0.96x in 1992, indicating median home value was 4% below the expected norm. New home sale prices then grew in line with personal income from 1993-00.

Following the 1989 Northeast peak, new single family median home value dropped by 2.3% over two years resulting in a Gap Ratio of 1.19x by 1991. Home sale prices were essentially flat in 1992-93 and, with growth in personal income, the Northeast Gap Ratio declined to 1.05x by 1993. New home sale prices then grew in line with personal income through 2000.

Prognosis

The percent decline in price necessary to eliminate the price to income gap (1 divided by Gap Ratio minus 1) as of January 2008, was -16% for the Northeast (Gap Ratio 1.20x) and -26% for the West (Gap Ratio 1.36x). This does not mean that new home values on a regional basis will decline by those amounts because nominal personal income growth during the next two to three years will reduce a portion of the existing gaps.

The current price to income gap in the West, however, is the largest since at least 1963 (oldest available Census Bureau data). It is not a coincidence that sub-prime lending was more concentrated in the West than in any other Region. According to the Mortgage Bankers Association, California and Florida accounted for 29% of all subprime ARMs outstanding, but 36% of all subprime foreclosure starts in the 4th quarter of 2007.

The near elimination of subprime residential mortgage lending standards which began in 2004 supercharged the already inflating West Region and Costal Florida home values to a degree not seen since at least 1963. Almost overnight, lending standards have returned so it is reasonable to conclude, all else being equal, that the rate of home price decline necessary to eliminate the existing price to income gaps will be faster than the declines following the 1989-90 peaks.

It is safe to say that the magnitude of the Regional peak to trough nominal median price decline will be less than 16% in the Northeast and 26% in the West. How much less will be a function of personal income growth and slope or rate of price decline. Significant new single family home price declines have already been documented.

For the period 2008-10 (Chart 2) per capita personal income growth is projected at a probably optimistic 3% and 4% annually for the West and Northeast, respectively, in line with annual growth during the last few years. Median home values in nominal terms will stabilize when the price and income lines converge; assuming per capita personal income at that time is growing in nominal terms.

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This article has 9 comments:

  •  
    Mar 27 08:54 PM
    Whats the median price decline in both regions so far? Is it possible to calculate yet?
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  •  
    Mar 28 02:34 AM
    Los Angeles is down 16.5% year over year (January 2007-January 2008). This would tie into his notion of a faster decline than the 1990 decline, which took 3 years to get to 16%.
    Reply | Link to Comment
  •  
    Mar 28 10:46 AM
    I like the attempt to quantify the situation, but it seems to me that the relationship between media value and per capita income in the base year would likely throw chart 1 off completely for all years. Doesn't it assume that the relationship was "right" in the base year ? If the assumption isn't true, it would seem to me that the reasoning is flawed. I agree that prices are historically high relative to incomes, but I am far from certain that this reasoning shows that.
    Reply | Link to Comment
  •  
    Mar 28 10:52 AM
    I would suggest plotting this as a spread over time, such as here. It is much more graphically helpful. nickgogerty.typepad.co...
    Reply | Link to Comment
  •  
    Mar 28 03:44 PM
    The income projection is most troublesome. I just got my annual raise of meager 2% yesterday. Inflation according to the US is 4.5%, but in reality higher still. If gas, food etc go up, I can't really allocate house payments to match. And also consider that compound interest (after tax write-off) makes every 1$ in house price increase really $2.2.

    I think we keep deluding ourselves with these 'historical' facts, when in fact this nation is getting poorer and things are getting worse.

    Somebody in power should start heeding reality or reality will deals with them (and with all of all)

    And I make well over 100K. Living in SoCAL though, it means nothing and I am buckling under financial stress.
    Reply | Link to Comment
  •  
    Mar 29 12:58 PM
    I too am living in So Cal and earning over $100K and it means nothing. Because I try to live within my means, I have not bought a home here due to the gross overpricing. But now, as the prices are starting to come down because many made bad investment choices, the government wants to step in and stop people from foreclosing. I have been patient and have been waiting for the opportunity to buy low, but...

    Seems like the government encourages irrational behavior.
    Reply | Link to Comment
  •  
    Apr 03 02:46 PM
    In reply to user 169490, it is true that base year relationships can change results but not by statistically significant amounts over the long term because, in this case, the underlying compared values historically exhibit low and similar degrees of volatility in terms of year over year percent change. Importantly and to your point, base year 1976 and the years preceding and following it were unremarkable in all four Regions. I would be happy to share the data with you. Email cdincesen@insuredaaabo...
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  •  
    Apr 06 12:33 AM
    if my real estate investments only went down 25% peak to trough i'd be throwing a party! i'm over weight in san bernardino county properties. mostly in hesperia. the local market for new residential construction peaked in may of 2006 at approximately $200 / sf. right now there are approximately 100 properties coming onto the market every day and about 30 go pending for the high desert area. the only res. properties selling are usually repos. their going for around $110 / sf. infill building lots peaked at around $115,000. now their worth $25,000 maybe. banks are only accepting comps for appraisals less than 2 months old so even if someone is willing to pay a premium for a new non thrashed house the comps are so bad that the houses won't appraise. local real estate agents will tell you that tract houses are losing 4% per month and customs are losing 3% per month (victor valley area). i've been in the business since 1986. houses in my little valley bottomed out at around 35% off and vacant land was off 66% in 1993. i'm guessing that we'll bottom at more than 50% off on houses in our little valley. i think that i read somewhere else that forclosures will spike towards the end of this year. we're still in a freefall in the victor valley.
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  •  
    Apr 13 04:42 PM
    In reply to user Dilbert. Appreciate the comment. No doubt you know your local market, but what has and continues to be happening locally for you is not at odds with the parameters of median new home sale price declines in the West Region discussed in the above article. That is because the Price to Income Gap, being based on median home value in the Region, is itself a median Gap or middle value with half being higher and half being lower. The Gap, no doubt, varies in each State in the Region and more so within the hundreds of local real estate markets in the California.
    Reply | Link to Comment
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