Sunday, March 23, 2014

Implications of stagnation in household income for real estate markets.

Issue:   Interest rates remain low.  Housing prices have increased since the financial collapse.  However, analysts differ in their assessment of the current market and future prospects.

An analysis stressing interest rates would find that home prices are still affordable.  For example, an oft-cited affordability index constructed by the National Association of Realtors suggests that home price payments on the median home are still relatively close to historic lows. 

Interest rates are not the only factor determining home affordability.   One measure of home affordability is the ratio of median household income to median house price.   A high ratio of median income to median house price indicates that home prices are affordable.   A low ratio suggests homes are expensive.

How does the current income to house price ratio differ from ratios that existed in the past?

Data sources:  The original source for both household income and home price data for this post is the Census Department. 

Household income was obtained from table H6 all races on the census historical household page (link below.)

https://www.census.gov/hhes/www/income/data/historical/household/

I obtained data on the median home price for the United States from the following page.  I used the value for June of each year.


The last June observation for the housing data is in 2011.

Our analysis spans the years 1975 to 2011.

I need more recent data and would also like regional and city-level data for additional posts.  People who can provide me with data should email me at Bernstein.book1958@gmail.com

Discussion of the data:

Information on median household income, median house price and the ratio of income to house price is presented at the end of this post.


Observations:

The income to price house price ratio was consistently higher in the 1970s, 1980s, and 1990s than in the 2000s.  The decrease in income to house price ratio in the 2000s was largely due to stagnation in income.  See the table on average annual income growth from 1975-2000 and from 2000-2011 below


Average Annual Percent Change in Income
1975-2000
5.2%
2000-2011
1.6%


On a short-term year to year basis there is much more volatility in house prices than in household income.  This is intuitive because even in a recession the vast majority of people keep their jobs.  However, a decrease in mobility and a decrease in the number of people moving up to a bigger house by a relatively small number of potential buyers can have a large impact on house prices.   One measure of the volatility of variables is the coefficient of variation.

Readers interested in this methodological point can look at the Wikipedia file on the coefficient of variation.


The table below on the coefficient of variation for the annual percentage change in household income and house prices highlights the higher volatility in housing prices compared to income.

Standard Deviation, Average, and Coefficient of Variation of Household Income and House Prices
Household Income Percentage Change
House Price Percentage Change
STD
0.028
0.065
AVG
0.041
0.055
CV
0.68
1.19


The peak income to house price ratio of 0.311 occurred in 1975.  The trough income to house price ratio of 0.198 occurred in 2006.

The collapse of house prices after 2006 led the income to house price ratio to rise to 0.232 in 2009.

The rebound in house prices has moved the income to house price ratio towards its pre-crisis value.  In 2011, this ratio stood at 0.208 closer to its 2006 value than its 2009 value. 

Concluding thoughts and caveats:  This analysis is limited to U.S aggregate medians on household income and house prices.  We don’t consider interest rates and do not consider other measures of income and house price that might be more relevant than the medians.

Our analysis suggests that there has been a substantial rebound in house prices relative to household income.   This ratio is much closer to the pre-crisis peak than the crisis-level trough.

The last year in my chart is 2011.   Housing prices have continued to escalate.  I wonder if the income to house price ratio is now below 0.198.

The evidence presented here suggests the stagnation of household income will limit the rebound of the housing market.  This could be a substantial concern if interest rates rise.


Median Household Income and House Prices for the United States 1975 to 2011
Year
Median Household Income
Median House Price
Ratio of median Income to Median House Price
1975
$11,800
$37,900
0.311
1976
$12,686
$46,100
0.275
1977
$13,572
$48,700
0.279
1978
$15,064
$56,700
0.266
1979
$16,461
$64,200
0.256
1980
$17,710
$64,900
0.273
1981
$19,074
$68,800
0.277
1982
$20,171
$69,300
0.291
1983
$20,885
$75,800
0.276
1984
$22,415
$80,500
0.278
1985
$23,618
$86,300
0.274
1986
$24,897
$91,200
0.273
1987
$26,061
$109,000
0.239
1988
$27,225
$111,500
0.244
1989
$28,906
$122,800
0.235
1990
$29,943
$125,000
0.240
1991
$30,126
$119,000
0.253
1992
$30,636
$124,500
0.246
1993
$31,241
$124,500
0.251
1994
$32,264
$133,500
0.242
1995
$34,076
$133,700
0.255
1996
$35,492
$140,000
0.254
1997
$37,005
$145,000
0.255
1998
$38,885
$148,800
0.261
1999
$40,696
$159,300
0.255
2000
$41,990
$160,100
0.262
2001
$42,228
$179,400
0.235
2002
$42,409
$190,600
0.223
2003
$43,318
$187,900
0.231
2004
$44,334
$215,700
0.206
2005
$46,326
$226,100
0.205
2006
$48,201
$243,200
0.198
2007
$50,233
$235,500
0.213
2008
$50,303
$234,300
0.215
2009
$49,777
$214,700
0.232
2010
$49,276
$219,500
0.224
2011
$50,054
$240,200
0.208
2012
$51,017


I intend to write more posts on affordability issues.  Readers who are interested in this post may also be interested in my work on long-term mortgages



Readers who are interested in this post may also want to look at my post on how an increase in interest rate might affect the ability of people to qualify for a mortgage.




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