Monthly House Payments, Rents, and Incomes

Submitted by Rich Toscano on September 4, 2008 - 9:51pm

Here's a look at monthly house payments (including mortgage and property tax) compared to incomes and rents:

Loads of exposition can be found in the full writeup at voiceofsandiego.org.

Update:

I'm not sure if people are hopping over to the Voice article so I'm going to include here a bit discussing the pros and cons of using monthly payments as a valuation indicator.

On the con side:

It is pretty clear that for most of the history displayed on the charts, the payment-to-income and payment-to-rent ratios hewed pretty closely to mortgage rates themselves. Typically, the monthly payment ratios would move up when rates were moving up and down when rates were moving down. It wasn't until the recent housing bubble, when the payment ratios shot up while rates dropped and then languished at generational lows, that this relationship broke down.

But the recent bubble is an abberation in which home prices rose not due to low rates but to an extended period of incredibly reckless mortgage lending. Looking back beyond this risky-lending-induced bubble, there just isn't much historical data to suggest that homes should necessarily be more expensive when mortgage rates are low and less expensive when rates are high.

The point can be further illustrated by comparing the recent bubble peak to the early 1980s, when double-digit mortgage rates prevailed. If monthly payments are a good valuation metric, then these charts suggest that the overvaluation of the recent bubble was not nearly as large as that seen in the early 1980s. This is ridiculous, of course. The recently burst bubble absolutely blew away prior booms in terms of magnitude, as a quick glance at the bubble aftermath depicted in this long-term foreclosure graph easily demonstrates.

On the pro side (this is reminiscent of a point made by pigg ltokuda earlier in the year):

While payments aren't a good valuation metric by themselves, however, they do have an influence. Monthly payments are a crucial element of the rent-or-buy calculation and will thus affect the level of demand coming from renters or investors jumping into the market. This phenomenon can perhaps be seen in the fairly consistent payment-to-rent "floor" in the second chart above.

All in all, given everything that's going on foreclosure/economy-wise and the sketchiness of using monthly payments as a valuation measure, I don't see these graphs as providing much indication either that the bottom is at hand or that homes are a particularly good "value" here.

(category: )

Submitted by EconProf on September 5, 2008 - 6:40am.

At first glance these charts give some ammunition to those who say its time to consider jumping in. The ratios are approaching their historic troughs, especially considering that the reported incoming data lags the grim reality of the last couple of months. Housing bulls will latch on to that.
On the other hand, some cycle-watchers claim that the higher the peak, the lower the ensuing trough. The mass psychology of crowds explains some of that--people overreact both at the top and at the bottom. Add to the bears' pessimism today's dreadful unemployment numbers and the worsening recession and it looks best to stay on the sidelines.

Submitted by FormerSanDiegan on September 5, 2008 - 8:41am.

Being at 1999 levels in terms of affordability is a little surprising. Taken by itself this would support the theory that we are near the beginning of the bottom in the near term. But, there are two major wildcards:
1. Availability of mortgage loans - It was easier to qualify in 1999 than it is today.
2. Threat of Higher interest rates - At a generational low in interest rates we should probably be at a generational high in affordability. We are not there. I would expect rates to reach up into the 7's or higher at some point during an economic recovery in the next few years (assuming that there still is a business cycle).

Submitted by peterb on September 5, 2008 - 9:22am.

Unemployment is rising quickly and foreclosures are also rising at an astounding rate and number. 2009 is looking to be an absolutely devistating year for the economy.Evidence of a global recession is gaining every day. "Affordability" is a moving scale and the scale is moving down.
Anyone that can somehow read into the data and trend as a bottom, is not looking very closely!!

Most economic historians agree that the bigger the bubble, the bigger the bust. We just had a global bubble in almost every asset class, all at about the same time. This equals the bubble of all time.
We are starting a very strong deflationary cycle.

Submitted by Fearful on September 5, 2008 - 10:09am.

Even just taking these charts at face value, the forecast would be for prices (monthly payments) to drop by another quarter to third, from 0.05 to 0.035 (payment to income), or from 1.3 down to 0.9 (payment to rent).

Thank you to Rich for continuing this analysis.

Submitted by cr on September 5, 2008 - 10:29am.

I did read the voice article :)

"Looking back beyond this risky-lending-induced bubble, there just isn't much historical data to suggest that homes should necessarily be more expensive when mortgage rates are low and less expensive when rates are high.

That may be true but in a sense, but don't those two things basically lead to demand? Given equal income and home prices, higher rates make monthly payments higher, and therefore less affordable, driving down demand, and eventually prices.

The other problem we have now, though I'm not looking at numbers as I type this, is incomes were relatively higher than they are today, and on the rise. Today? Not so much.

So even if inventories fall under 6 months, the price to buy gets to 10% more than rent, and the median income gets to 4X the median price, is still doesn't mean people will have the jobs, the down payment, or now, even the guts to jump in, particularly in this market.

Submitted by urbanrealtor on September 5, 2008 - 11:28am.

this post is going to be too long.
Sorry.
I am addressing too much here.

@ rich:
con #1: This is an astute observation but I am not clear how it is a con>
Con#2: I think it would be inaccurate (or at least incomplete) to remove rate levels as a relevant variable for the stampede. It appears that the rates were the original drivers for demand (and thus increases in valuation) which stirred desire more broadly (sometimes in the less qualified). The point at which the innovative (sometimes stupidly innovative) lending seems to come into play is in the conversion of that desire into effective demand.
Con#3: Your point makes sense here but is missing a major component to be compelling. That component is volume superimposed directly on p2r or p2i. Did people buy in high volume with those high ratios? I do not know. I suspect they did not and that those ratios are supported buy "must buy" situations (much as ultra-low ratios are supported by "must sell" situations). Can you shed light on this?

pro#1: I think that the point about the microfoundational calculations is important and valid. The only addition I would make to this is that many (or all) buyer practice some amount of market timing. The model employed by most buyer for this is somewhat crude and pedestrian. At its simplest level, this model suggests that buying makes sense in 2005 because prices are going up (and therefore its a good investment) and that buying now or in year is bad because prices are decreasing. Many on this blog are smarter than that but lots of people think this way. Can you talk a little about market timing?

One other thing: It is not referenced in your chart but I think it is very important in San Diego. Can we get data on attached housing like this?

@econprof: I simultaneously find your logic compelling and find it somewhat beholden to the afore-mentioned folk-model of cyclical demand and value.

@FSD: I think that the threat aspect is less likely to motivate action than the boom. In the boom there was the threat of missing out and a potential reward of enrichement. I think a purely negative threat (which is how I think this is seen) is unlikely to compel action.

@Peter: As a global(this term used in the macro-market-wide sense) megatrend, you may have a point. However, many of us make our living on smaller trends. On that note, I keep seeing housing inflation on the rental front. As I see the rent and buy expenses converge, I see more and more all-cash buyers and more first time landlords cash flowing positive. In some areas, this is turning into a full-blown backstop (eg; central 92103, and parts of 92116) for the last few months.

@Fearful: We are already there in a lot of places.

@Coop: Good point. I think these demand features are better seen as cause and effect rather than "if a then b". In other words dynamic (regardless of equilibrium).
Your second point I don't see. Regardless of guts or whatever else, there are alway those able to find deals and who seek passive income.

Submitted by RyanInSD on September 5, 2008 - 11:48am.

There is another phenomenon of the downturn that is becoming more pervasive. There is a decline in people's enthusiasm for home ownership.

One of the motivations for buying a house for many has been the expectation of steady appreciation. (Not for everyone, but it does exist in varying degrees in many buyers.)

With the market flat to falling and unlikely to appreciate anytime soon, a lot of people will be asking themselves why are they paying such a high premium for ownership over the cost of renting a comparable property? Up until the bust, most people would justify a premium for ownership cause they were getting a healthy amount for appreciation.

It's more expensive to rent assets that depreciate. Houses have been cheaper to rent than to purchase because of the appreciation component.

What happens to prices when the appreciation component buyers assign to a home purchase is zero?

Given, the fact many potential buyers are hesitant to pull the trigger on a purchase due to fear of buying a depreciating asset, the bottom may be the point where renting becomes more expensive than owning.

You want to be buying when home prices reach their Floor or bottom level and be selling when prices approach the Ceiling or top.

The top or Ceiling is the high limit of prices based on exceeding income to home price levels where prices can no longer be sustained. The Floor is when the home value reaches the level where it could generate rental income returns acceptable to an investor. Market prices move up and down between the Ceiling and Floor. Check it out.

http://www.ushousingmeltdown.org/home-va...

Submitted by FormerSanDiegan on September 5, 2008 - 1:43pm.

You want to be buying when home prices reach their Floor or bottom level and be selling when prices approach the Ceiling or top.

Thanks for the great advice. Geez, I wonder why I didn't think of this first.

Submitted by RyanInSD on September 5, 2008 - 2:24pm.

It may seem obvious, but there's are thousands of people who overpaid, buying at the top of the market in 05 and 06. Furthermore, according to a recent analysis a growing percentage of homeowners find themselves upside down in their equity.

Until this downturn heightened people's awareness, most people didn't pay much attention to the factors that cause home prices to rise or fall. They just listened to their realtors believing real estate always goes up.

It's a certainty, many of these people would re-think their buying and borrowing decision had they been better informed and obtained other information besides that promoted by the shills from the real estate industry.

Submitted by cr on September 5, 2008 - 3:24pm.

RyanInSD wrote:
It may seem obvious, but there's are thousands of people who overpaid, buying at the top of the market in 05 and 06.

Right. Likewise, there will be people still holding on to and able to afford their homes who bought at or near peak but will sell because now prices are dropping and they're completely upside down.

If they could and would hold on they would eventually build equity back up and be able to sell at a profit, but people are irrational.

They were irrational on the way up, and will be on the way down.

There's still enough hope floating around for a 2009 recovery that people aren't all selling yet IMO.

Urban, that's more what I was talking about, guts. Not so much to buy low, but to think rationally, and realize when it is a good time to buy. I beleive we will start seeing people think housing will never turn around or wait so long to buy that they miss the bottom and next thing they know they're buying in a bubble again.

Submitted by Rich Toscano on September 5, 2008 - 3:27pm.

UR - These charts don't attempt to be a timing model... they are intended to answer the question of how expensive houses are (in terms of purchase cost last week and cash flow this week) compared to history.

No, I don't have such data on attached housing. Do you think it would look significantly different?

Re the cons questions you ask -- there are only 2 cons; #2 in your list above is the explanation for why the relationship cited in con #1 broke down recently.

I think #1 is very much a "con" to using payments as a valuation ratio for reasons explained in the post.

I don't think you can say that low rates caused the stampede because the farther-back data just doesn't support the idea that people stampede into houses when rates drop. I think it's securitization and thus greater availability of mortgages -- not low rates -- that started and then continued the stampede.

Re your con #3, I don't have data on that but I don't see how it invalidates the idea that monthly payments are a sketchy valuation metric.

Rich

Submitted by dumbrenter on September 5, 2008 - 3:32pm.

Rich, Thanks for the data.

May I ask why the two ratios "Monthly Pmt to Income" and "Monthly Pmt to rent" are tracking each other so closely? Other than the period between 2001 to 2004, these ratios seem to be highly correlated, right down to the little glitches on the graphs. While the range on Y-axis is different, the linear delta between those two graphs is also the same. Since the numerator in both these ratios is the same, it follows that monthly income and monthly rents track each other very, very closely. I find that hard to believe.

I am sure you might have checked already, but by chance, was there an error where you might have copied the same data but with a different scaling factor??
Thanks

Submitted by Rich Toscano on September 5, 2008 - 4:51pm.

dumbrenter wrote:
Rich, Thanks for the data.

May I ask why the two ratios "Monthly Pmt to Income" and "Monthly Pmt to rent" are tracking each other so closely? Other than the period between 2001 to 2004, these ratios seem to be highly correlated, right down to the little glitches on the graphs. While the range on Y-axis is different, the linear delta between those two graphs is also the same. Since the numerator in both these ratios is the same, it follows that monthly income and monthly rents track each other very, very closely. I find that hard to believe.

I am sure you might have checked already, but by chance, was there an error where you might have copied the same data but with a different scaling factor??
Thanks

I'm not sure why you'd expect rents to vary much from incomes in the short term given that incomes are the biggest influence on rents...

Anyway, the short term zigs and zags in these ratios are caused entirely by home prices, which are a lot more volatile than changes in either rents or incomes.

Rich

Update: I read your thing again and I realize the confusion -- it's with this:

"it follows that monthly income and monthly rents track each other very, very closely."

That does not follow, actually -- this is caused by the fact that the vast bulk of a monthly movement in the ratio is caused by home prices (the numerator in both cases).

Submitted by peterb on September 5, 2008 - 6:33pm.

I think if you examines many factors in the last couple of RE up cycles in CA, you'll see the main constant of low unemployment. By this, I mean under 6%. And it has to get there and stay there a year or two. This is rational as it brings migration into the area and instills in people a sense that they can commit to a 30 year mortgage with some sense that they will have income to pay the mortgage. I've looked closely at 1960 to 1970, 1980 to 1990 and 1990 to 2006. Despite mortgage rates that jumped all over the map, up cycle always had unemployment in the 6% and under range.
Just my 2 cents.
For those out there that mainly want to be a landlord, and thus look for cash flow to be positive....careful what you wish for, you could be in a property a long time before you ever saw appreciation. And all the while "enjoying" the job of a landlord.

Submitted by CA renter on September 6, 2008 - 1:26am.

Some other thoughts to ponder:

1. How many existing "owners" had equity during the last peak vs. today's "owners"? If today's owners have less equity (lots of 100% LTV loans out there), then there is more downward pressure today. Though the past housing cycles were volatile, people still had to actually **qualify** for a loan and prove they could reasonably pay them off.

IMO, there are more "distressed" owners out there who are living on the edge. It would also be instructive to see what personal savings and debt looked like then vs. now.

2. Baby Boomers...If we take 1946-1964 as birth years, and assume that most people enter child-rearing and home-buying years between 25 and 40 years old, the Baby Boomers reached peak buying years between 1971 and 2004, with the bulk of them buying in the 70s and 80s (IMO, the more "fundamental" cause of the previous housing booms, though credit was also involved then...to a much lesser extent).

Contrary to David Lereah's thinking, I think Baby Boomers will begin cashing OUT of investment properties and downsizing, as rentals are a LOT of work and they can still get a good deal of money from their sales if they didn't cash-out/HELOC against the houses.

3. What percentage of a family's income went to food, healthcare, education and retirement during the last bubbles vs. today?

With more people having to pay out-of-pocket for these things today, there is less money left for housing costs.

4. We still have a recession, globalization -- further deterioration in pay and benefits for most working people, and we are at an historic peak in the credit markets. IMHO, there are tremendous deflationary forces that people are not taking into account, and I believe housing prices will fall further and longer than even most bears believe.

Submitted by peterb on September 6, 2008 - 8:59am.

Excellent points CA renter.
Evidence over 2000 NOT's per month in SD county now and the number is growing. Mr Mortgage makes a very good arguement for Alt A, prime and jumbo's to start becoming NOT's in 2009 at much greater number than we're seeing now. And probably higher dollar amounts per loan, compared to subprimes.

Couple this with unemployment rising and tougher loan qualifications, and 2009 is looking to be the perfect storm for real estate.

I would also hazard a guess that this downward pricing pressure will extend to rents as well.

Submitted by bobl on September 6, 2008 - 9:08am.

Even though all the fundamentals point towards more drops, we are living in different times. The latest is that the treasury will inject up to 800 billion into Freddie/Fanie. When it gets to the point that 1 out of 10 homes along the California coast are in foreclosure, the media will be all over this, as these "poor" folks in 1 million dollar homes face homelessness. We live in an age of entitlement.

I just don't believe the government will allow this situation to follow natural recourse.
Effectively, through taxation and redistribution of money, forgiveness of huge debt will be reaped upon those who made irresponsible decisions. I think we may very well be near the bottom, even at the high end, just because of the government intervention.

Even though the current bailout bill doesn't help many of the Alt-A Option Arm borrowers, I'm sure new legislation will kick in to make up for it. Plus new laws to prevent people who are foreclosed from being evicted. It already takes over a year.

We live in a different country than the one that I grew up in. I had to move to San Diego as part of a job switch, otherwise I would never have come here after living years away from the state in the Southeast, where people view homes more as a place to live and raise a family than as a ticket to wealth. It is unbelievable how many people here sincerely believe that house appreciation is some soft of California right and that the government needs to fix it if it doesn't happen, even after their house appreciated 200 - 300% after 6 years.

Submitted by peterb on September 6, 2008 - 10:14am.

I agree that we are a "bail out" nation at this point. But it's mostly for the frat boys on Wall Street. The 2009 housing debacle that's going to undfold will come as a "surprise" to our govt and financial institutions and thus allow most of the carnage to take place before they create some sorry legislative band-aid for the masses.

Market forces of this magnitude are extremely difficult to resist without corrupting the system to its core.i.e...socializing housing in the US. Although this may happen, I really dont see our govt as caring too much for the common man. Case in point, BS and other Wall Street firms are deemed "too big to fail" while many banks will go
down in flames accross the country. And keep in mind that the BS deal did take the stock price from $90 to $10 or less. That alone hurt a lot of people.

Regardless of how it ends, it is a historical time !!

Submitted by FormerSanDiegan on September 6, 2008 - 10:52am.

Rich Toscano wrote:

I don't think you can say that low rates caused the stampede because the farther-back data just doesn't support the idea that people stampede into houses when rates drop. I think it's securitization and thus greater availability of mortgages -- not low rates -- that started and then continued the stampede.

Rich

Rich - I agree that securitization was a major catalyst in the most recent run-up, but there is evidence of interest rates impacting housing costs in your charts.

Let's examine the monthly payment to rent ratio. FOr the most part monthly payments track interest rates on this chart. However, there are several distinct periods where they diverge.

1984-1985 : Rates increased from about 12.5% to nearly 15%. However, house payment to rents declined. Was this due to increases in rents in the economic recovery following the double-dip recession of the early 1980s ???

1988-1991 : Rates declined by about 10% (from ~ 10 to less than 9%) and house payment to rent ratio increased by about 30%.

The 1988 to 1991 period is particularly interesting. It appears that over the short run or at turns in the economic cycle, that changes in interest rates may act as a catalyst.

I agree that over the long term monthly mortgage payments to rent ratio and interest rates are highly correlated. But over 2-3 year periods, changes in the direction of rates (or perhaps underlying economic conditions associated with them) may act as a catalyst.

Submitted by PadreBrian on September 6, 2008 - 1:18pm.

So it looks like we are back to 2001 levels.

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