What price should you be paying for a home? It's easy to calculate if you can see how median home prices and median incomes correlate.
What price should you be paying for a home? It's easy to calculate if you can see how median home prices and median incomes correlate.
View Housing Market Watch RSS feedWhat price should you be paying for a home? It's easy to calculate if you can see how median home prices and median incomes correlate.
Historically, median home prices and median incomes have shared a close relationship. From the mid-1970s to 2001, the ratio of median housing value vs. median household income consistently stayed between 2.6 and 3.0.
What this essentially means is that median home prices averaged 2.8x the median household income over the last 30 years. Using this 2.8 formula, it 's easy to estimate what the median home prices would be if the recent housing bubble had never happened.
| Current Median Price* | What the Median Price Ought to Be | % Difference |
|---|---|---|
| $208,400 | $134,692 | 35% |
Median household income information for 2007 is not yet available, so we will be using median household income data for 2006 in this example and in the following examples. This shouldn't make that much difference since household incomes increased at most by 4 percent (and that's a very generous estimate) in 2007.
The median U.S. household income is $48,201, according to the Census Bureau. When we multiply this number by 2.8, we get $134,692. That's what the U.S. median home price ought to be right now. The actual median home price, however is about 35 percent higher that that.
| Region | Current Median Price* | What the Median Price Ought to Be | % Difference |
|---|---|---|---|
| Northeast | $258,600 | $145,760 | 44% |
| Midwest | $159,800 | $133,941 | 16% |
| South | $173,400 | $122,875 | 29% |
| West | $309,800 | $146,297 | 53% |
It is obvious to most people that we're in the middle of a nationwide housing bubble. Nevertheless, there are still naysayers telling us that there are local bubbles only.
Using the 2.8 formula, it is clear that local bubbles aren't the problem. Median home prices show inflation in every U.S. region. In the West, with a median household income of $52,249, median home prices are more than double what they should be. There is a similar situation in the Northeast, where the median household income is $52,057.
Median home prices are somewhat lower in the South and Midwest, with median household incomes of $43,884 and $47,836 respectively. Even so, prices are still 30 percent above where they should be in the South and 16 percent above what they should be in the Midwest.
| Current Median Price* | What the Median Price Ought to Be | % Difference |
|---|---|---|
| $402,000 | $158,606 | 61% |
There is no doubt about it. California was the state that was hit the hardest by the housing bubble. Although California's prices have always been slightly elevated, they grew by great leaps and bounds during the housing boom.
The result is that home prices are 61 percent above where they should be given California's median household income of $56,645. In certain areas, such as Oakland and San Francisco, median home prices are so inflated that they are over 11 times the median household income.
Absolutely. Prices have already fallen by six percent nationwide and over 11 percent in the West in a year-by-year comparison. Home prices must continue to fall in order for the average American to afford a home.
The real question is: how long will it take?
The U.S. government seems to be doing everything it can to prop up prices. Before you applaud these efforts, it's worth noting that while their quick-fix methods could work in the short term, all they will really do is to ensure that we have a slow fall.
The truth is that propping up prices and thus prolonging the correction will not solve anything. The Japan Ministry tried this same scheme during the Japan correction and it was a complete disaster.
All we can really do now is to prepare for the fall. It will come and when it does, it's going to hurt. But that's the price that must be paid for allowing the market to become artificially inflated.
*Current median price refers to median prices of existing homes as of December 2007. Current median figures were obtained from the National Association of Realtors' EHS data.
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