Monday, September 20, 2010

The Truth About Home Prices

The Truth About Home Prices
Median Single Family Home Price to Median Family Income Ratio Over Time (1/1989 to Present)

As you can see on the graph below, Median Single Family Home Price to Median Family Income Ratio Over Time (1/1989 to Present), the current Median Single Family Home Price to Median Family Income Ratio ("Ratio") is higher than at any point during the entire period evaluated except for the 2002-2008 housing bubble. The problem is that unemployment is higher that any time except for the prior few months. The question is : How can home prices, per the Ratio, be relatively higher than any non-bubble period when unemployment is extremely high and foreclosures are at record levels? The answer is: artificial government housing market propping. Once this market propping is over the organic (and true) housing market will become clear. That clarity will show that housing prices will decline as soon as this artificial government market propping ends see my previous blog post: Home Prices Headed Down.

In short, housing prices will continue to decline because current housing prices still do not reflect the current economic reality: the economy is poor, but housing prices remain "average". This simply does not make sense. This is not my opinion, but, rather, is proven by the facts. I analyzed the data in the NAR Home Affordability Index (HAI) from 1/1989 through 7/2010 and found that the Median of the Ratio of Median Home Price to Family Income is 2.92 and the Average of the Ratio of Median Home Price to Family Income is 3.07. Over this same period, the lowest reading occurred in 12/1990 at 2.654. Therefore, it is safe to say that from an historical perspective the typical price of a median home should be about 3 times the median family income. The 7/2010 reading was over 3 at 3.032 (i.e. over 4% higher than the historical median and about the same as the historical average). The problem is that we are not in a “typical” economic environment – we have record foreclosures that seem to persist and near 10% unemployment. Given that the lowest reading of 2.654 occurred in 12/1990 and that our current economic conditions are far worse than 12/1990, it is logical to conclude that the Median Home Price to Family Income Ratio should be below 2.654. If the ratio declines to 2.5, home prices will decline by over 21%. If the ratio declines to 2.5 and family incomes decline by just 5%, home prices will decline by nearly 28%. Given that personal incomes are declining and that a 2.5 ratio is probably a bit optimistic, I believe it is very feasible that home prices will decline by an additional 30%. As a result, there will be more short sales and foreclosures. See the graph below for a representation of the Ratio of Median Home Price to Family Income Over Time and how it compares to the Average and Median of that same Ratio.

The Truth About Home Prices - Median Single Family Home Price to Median Family Income Ratio Over Time (1/1989 to Present).

The graph shows that houses are still overpriced when compared to incomes. Keeping homes overpriced by artificially allowing more home buyers into the market and encouraging other home buyers to purchase more expensive homes (because of artificially cheap money) is completely irresponsible. Why should Americans be happy about being forced to overpay for homes (due to having to compete with home buyers who should not be home buyers, but only are do to the "government housing stimulus" described above) - that only leaves less money available for saving, investment, non-debt spending, etc. In short, it makes it harder and harder to get by on their current incomes. The American Dream is being killed by unnaturally high home prices, which are made possible by irresponsible government housing market propping. The government should just let home prices fall to where they should naturally be given the current economic situation (i.e. a lot lower than they are right now).

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