Housing apocolypse revisited

Real Estate Agent with Century 21 Results Realty

I ran across a post on Active Rain that pointed me to an outside article that talks about the need for at least a 20% reduction in home prices in order for families to be able to afford to buy. Well, I love it when there are specific claims and statistics. I can usually verify and refute or support specifics. When someone tosses out some general and off the cuff stats, they can’t be verified.

So, I ran into one problem, there was an affordability index that was quoted, and I couldn’t find it in order to check the methodology. But, my son took a long nap (wiped out by Christmas present opening) and so I made my own. Here is a quote from the article:

Today, median home prices are 3.5 times the size of median annual family incomes. This may be down from the recent peak of 4.2 times incomes reached last year, but it’s way above the 2.8 times that home prices averaged during 1984-2000, when lots of homes were bought, sold and built.

And if you think 2.8 is low, check out the early 1970s. That was when home prices were only 2.3 times median family incomes, and housing was selling like gangbusters.

One major homebuilder recently proved that people will buy if the price is right. The firm slashed prices by 20-30% one recent weekend - and wound up selling more than nine times as many homes as it did on previous weekends.

To get prices back to 2.8 times family incomes would require a drop of 20% from today’s levels - and this does not take into account interest rates and lending standards.

To equal the affordability of the early 1970s, prices would have to fall a whopping 38%.

Well, that didn’t seem right to me (BTW, I added the bold). I know that the interest rates haven’t been this low in decades, and they would have a serious impact on affordability. I also know that lending standards were tighter in the 1970s than they were a couple of years ago, and even with the tightening, standards are still pretty open by historical comparison.

So, I knew that a simple multiplier would not give a true picture of affordability. I also knew that I couldn’t give any meaningful and measurable comparison to lending standards, so I left that alone. But, this is what I found.

In the Lane’s Affordability Index:

  • 2005, the peak of the bubble yielded a LA of 3.0. Median Price was $319k (all dollars are 2007 constant dollars), but the interest rate was only around 5.85%. Median family income was a touch over $60k.
  • From 1963 to 2006, the average was 2.8.
  • The ugliest years for the LA were 1981 and 1982. Interest rates hovered around 14%-15% (I know there were higher rates, but these are as reported by the FHFB), and prices were around $173K. Payments on the median homes were about $1700/mo. and the median family income was around $49k.
  • From 1984-2000, the average of the LA was 2.9.
  • In the 1970s, the average was 2.6. The same as 2003.
  • In 2003, the median price was $278k, and the interest rate was 5.67% and the median family income was about $60k.

What I take away from that is that IF one removes interest rates, the numbers given by Dr. Kellner would not be off-base. However, interest rates ARE a very important component in affordability. Using a simple multiplier of income to home price is disingenuous at best. When some points of the measurement the interest rate is triple the rate at other times, and during the target periods it is from 50-100% higher, not including it is just irresponsible.

When factoring interest rates, in order to reach the affordability of the 1984-2000 period, prices would need to drop by about 4% from 2005 levels. To hit that magical average af 2.6 from 1970-1979, prices could drop by 10% from 2005 levels (not far to go, BTW) and interest rates would need to be around 5.75%… there was a slight increase in income.

Let me explain what I did…

  • I took the average price of conventional homes purchased as well as annual average interest rates from the Federal Housing Finance Board.
  • For the average family income, I hit up the US Census Bureau.
  • This is the constant dollar calculator I used.
  • Using this data, I crunched numbers. I figured out the payment with 20% down for the median house, and then took it as a percentage of the median income and multiplied the percentage by 10. (eg. 31% = 3.1).

These numbers ARE NOT directly comparable to the numbers from Dr. Kellner’s article. However, the time periods he mentions obviously are, and my numbers are just as valid comparing them to each other as his are.

So, Dr. Kellner, please feel free to give out your methodology. I would be glad to take a look. I shoot straight. I can be wrong.

If this post was interesting to you, you might read these other posts I wrote previously:

Are we on the edge of a calamitous housing bubble?  The Gwinnett county, GA, perspective.

The sky is falling… and the bubble is coming…

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R. B. "Bob" Mitchell - Loan Officer Raleigh/Durham
Bank of England (NMLS#418481) - Raleigh, NC
Bob Mitchell (NMLS#1046286)

Great post Lane!  While "affordability" can slow a particular markets rise in prices, people have to remember that there generally is a reason that an area is appreciating (or has appreciated) quickly....it's because that is where the people want to live!


Bob Mitchell

ValueList Real Estate Services, Inc. 

Dec 25, 2007 01:45 PM #1
Jessica Horton Jessica Horton Realty
Jessica Horton - Jessica Horton & Associates - Griffin, GA
Jessica Horton: I'm not #1... You Are!
So people have to pay more to live closer to all those malls?  Is that what you are saying? =]

LOL!  Good post!

Hope you had a very Merry Christmas!  2008 is going to ROCK!
Dec 26, 2007 12:15 AM #2
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Bob - I agree with you to a point.  The point comes when the people that populate an area can no longer afford to populate the area.  When the area gets big enough, it no longer becomes convenient for the people that make the fries to get to work... then the area has to have a price drop.  If we're talking about the country as a whole, then we have a bigger problem. 

The will always be pockets of the market above and below average, but even the Bay area needs to have affordable and ownable housing for more than just the way above average people.  

Jessica - Not as exciting as your news/market report... but I needed to set the record straight.  

Dec 26, 2007 01:29 AM #3
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