Thursday, October 23, 2008

"Equlibrium" House Prices

I was a 1989 Seal Beach buyer at the then highest prices ever. My wife was pregnant with our first child and I felt then that house prices might leave me behind for ever.

By 1992, I was wishing I had seen information on house price and inventory history like the information a number of excellent blogs present and link to these days.

Any market intervention - be it billions of federal dollars thrown at housing or a real estate owner saying that real estate "never goes down" - has only a temporary effect. The market goes where the buyers and sellers collectively decide.

We can all guess where that might be, and everyone is entitled to their own opinion.
For better or worse, throughout history, voicing an opinion contrary to the self interest of others has often invited unpleasant responses, blogs are no exception.

Now, my opinion for what little it is worth.

I believe that there is a fundamental numerical relationship between 1) personal income and 2) housing rent and 3)housing prices.

Stated differently: 1) A person can only pay a certain percentage of income for rent and 2) The rent a house commands times some multiplier determines its "equilibrium price"

By "Equilibrium price" I mean the price the market will tend towards as disturbances -- from Fannie Mae trillions to high or low interest rates to "my special neighborhood" etc., etc., etc. -- are abated. (Of course they will never be eliminated)

If we can agree there is a linkage between income and rent and house price, then we are merely discussing the normal ranges of the relationships.

Let's assume median two-income household income to be $70,000 in Southern California in 2008. Can someone provide some statistics there?

I'll suggest that the normal rent is 25% to 33% of personal income. Can we have some discussion on that?

Second, I'll suggest that the equilibrium price of a house is around 120 times monthly rent. Comments?

(Anecdotal data: I'm a CPA and the the best real estate deal I have ever seen a client make was 8 units in Phoenix purchased in 1996 for 80 times rent. It "penciled" and the buyer made money from day one.)

If you will allow me, here is a calculation using this income- rent-house price model:

Median household income is $70,000 per year, or $5,800 per month.

30% of income paid as rent is $1,750.

$1,750 rent times 120 gives a median house "equilibrium price" in the broad swath of median income - from Chatsworth to Pacoima to Downey to Riverside to San Bernardino to Garden Grove to Tustin - of $209,000.

This may sound low to many ears, but since 1985, housing prices have been held temporarily higher by government actions to cause easy lending: 1) raising the FDIC limit to reduce depositor interest in mortgage quality, leading to the 1980's lending frenzy, and 2) Fannie and Freddie buying trillions of low quality and inducing Wall Street to forget to check if mortgages could reasonably be repaid by the debtors.

With these two factors dead, we may now tend to a lower equilibrium price (in every neighborhood).

I would be greatful if those who disagree with me would suggest a better market model and name the next government program to boost housing prices so I can get in on the deal.

Ps. It may be that inflation is the next step for the government. That would make housing hurt less and put the hurt on savers (whose money is just in piles and those on fixed incomes (think very small Social Security cost of living adjustments as prices and taxes soar.)