Why “Affordability” Doesn’t Dictate Home Prices

December 16, 2009

by Mike Simonsen


Ever wondered how in an entire state like California housing prices are able to stay so seemingly unaffordable seemingly forever? Even after two years of bubble correction, homes in most of the state (and other markets like New York) remain as out of reach for the average family as they ever were.

If the average home is priced out of reach of the average person, that’s gotta be a bad sign, right? Surely the average family in the San Francisco Bay Area can’t afford an $850,000 home. Prices must come down from here, right?

Wrong. It turns out that “affordability” (as measured by a market’s median income vs. it’s median home price) has no bearing on where home prices are going. Home prices do not come down simply because they’re out of reach for most people who live there.

Relative affordability of homes as measured by active inventroy vs. population

Relative affordability of homes as measured by active inventory vs. population. As you restrict supply per person, prices go up, pretty linearly. Source: Altos Research. Click for full view.

Econ 101 teaches us that prices, of anything, are merely a function of supply and demand. The bubble was a function of massive demand stimulation. Sure we added some supply, but we financed mega-demand. Prices jumped.

But chronically unaffordable markets, prices are a function of supply, specifically supply relative to the market size. That is, number of homes for sale relative to how many people might want to buy homes.

It turns out that, in American cities, there is a pretty consistent percentage of the population that wants to buy a house. Demand per population is roughly the same in Dallas as it is in San Francisco. What’s different between Dallas and San Francisco is supply (aka “inventory”).

So this morning, I whipped together this chart. Median Price on the Y-axis, and population per active listing on the X-axis. What it shows us is something very powerful:

In affordability terms, there are simply not enough homes for sale in the pricey markets for them to be allocated to the “average” family.  In San Francisco there are four times more people for that one listing than there are in the rest of the country, that home need be only “affordable” to the  top quarter. (editorial aside: in California this phenomenon is largely a function of prop 13 which among other things acts as a giant rent control for the whole state. Rent control means fewer people move. A lot fewer.)

The illustration teaches us more than that. We can use it to see when prices get out of line with what their inventory (supply) and population (demand) would dictate.  I plotted Las Vegas and Phoenix from July 2007 (purple dots) so you could see their post-bubble adjustment. By this yardstick, those towns were bound to adjust and look to be now about fairly, “affordably” priced. San Diego looks to be above the trendline, but the percentage deviation isn’t that big, so that’s not particularly worrisome.

Notes about the data here: We used single family home inventory and median income from Fannie Mae.  This is NOT a view of people per homes,  nor is it a view of people for homes that might be for sale if the giant pool of shadow inventory hits the market, it is a view of people per homes for sale right now, which, surprise surprise, is how prices get determined.

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