charles hugh smith-Why Is the Median House Price Still Rising?

Why Is the Median House Price Still Rising? (July 26, 2006)

All Homes	No Sold Jun-05	No Sold Jun-06	Pct. Chg	Median Jun-05	Median Jun-06	Pct. Chg
Alameda	2,730	1,991	-27.1%	$581K	$593K	2.1%
Contra Costa	2,640	1,900	-28.0%	$558K	$592K	6.1%
Marin	454	435	-4.2%	$815K	$829K	1.7%
Napa	209	189	-9.6%	$608K	$638K	4.9%
San Francisco	723	652	-9.8%	$760K	$778K	2.4%
San Mateo	917	765	-16.6%	$752K	$759K	0.9%
Santa Clara	3,220	2,562	-20.4%	$645K	$684K	6.0%
Solano	1,147	732	-36.2%	$449K	$482K	7.3%
Sonoma	974	666	-31.6%	$557K	$587K	5.4%
Bay Area	13,014	9,892	-24.0%	$610K	$644K	5.6%

(source: DataQuick Information Systems' July 19 press release, Bay Area home sales continue to drop, prices reach new peak)

OK, Mr. Housing Bubble Bursting, how come San Francisco Bay Area housing prices keep rising? Doesn't that puncture your "the housing bubble is popping" thesis? Good question.

According to Dataquick (click on link above for their full report), sales in the nine Bay Area counties (which have a population of about 7.5 million) dropped 24% even as prices rose 5.6%. (Emphasis in bold is mine.)

A total of 9,892 new and resale houses and condos were sold in the nine-county region last month. That was up 9.1 percent from 9,064 for May, and down 24.0 percent from 13,014 for June last year, according to DataQuick Information Systems.

While the year-over-year decline was the fifteenth in a row, last month's sales count was the highest since October last year when 10,508 homes were sold. The average June sales count since 1988 is 9,840.

The median price paid for a Bay Area home was $644,000 last month, the third record in a row. That was up 2.1 percent from May's $631,000, and up 5.6 percent from $610,000 for June a year ago. Last month's year-over-year increase was the lowest since May 2003 when the $427,000 median was up 3.4 percent.

The typical monthly mortgage payment that Bay Area buyers committed themselves to paying was $3,183 in June. That was up from $3,091 in May, and up from $2,651 for June a year ago. Adjusted for inflation, mortgage payments are 25 percent higher than they were at the peak of the prior cycle sixteen years ago.

Indicators of market distress are still largely absent. The use of adjustable-rate mortgages has decreased the last half year. Foreclosure rates are coming up from last year's low point, but are still below normal levels. Down payment sizes are stable and there have been no significant shifts in market mix, DataQuick reported.

Is this some sort of statistical legerdemain, or does it simply mean people are continuing to pay higher prices for housing? There may be some statistical skewing here, but I don't have the data to make that analysis. For instance, the lower-priced homes may actually be dropping in price, but a relatively small number of very expensive homes could mask that drop since all the sales numbers are combined.

BUt let's just grasp the nettle and wonder how sales could drop by 24%--clear evidence that demand is slowing--yet prices continue to rise, albeit at a slower pace? This phenomenon is not unknown in other markets; in the stock market, one sign of a market which is topping out is a narrowing of market breadth even as the indices continue to rise. What does that mean? Simply that fewer stocks are rising, but their market value is big enough that their advance lifts the entire index. So even if 90% of the stocks are flat or falling, the top 10% big-capitalization stocks can continue to drag the entire index higher. The analog would be a few $2 million homes masking a decline in the $450,000 segment.

But this data is clear: about 10,000 people paid the going price in June for a home in the Bay Area. So now we come to a Butch Cassidy-Sundance Kid moment: "Who are these guys?" Indeed. Who is still buying aging bungalows for over $600,000, even as the mortgage costs $440 more than a year ago (not to mention higher property taxes)? Affordability statistics tell us that only 10% of Bay Area residents can afford a median priced home, so--who's still buying? Don't the majority of these high-value, high-wage folks already own a home?

As reported in the U.S. News & World Report:

In Los Angeles, the cost of home owning has doubled over the past five years, rising from 31 percent to 55 percent of median income. That means only 2 percent of the homes sold there are affordable by families earning the area's median income of about $47,000 a year. To qualify for conventional financing of a median-price home of $500,000, with a 20 percent down payment, buyers would need an annual income of about $120,000. In New York, only 6 percent of those who earn a median income can afford to buy a median-price home. In San Francisco, the number is 7 percent.

I have two theories. #1.: Many of these buyers sold late last year near the top, and since they cashed in their winnings, the absurd valuations seem "normal" to them. In other words, if you sold your house for $750,000, then $800,000 doesn't sound too outrageous. Not everyone buys a replacement house immediately; and since sales have been dropping for months, the pool of people who sold out in 2005 is larger than the pool of current buyers.

A certain number of people who cashed out moved from the area, of course, and so they have left the pool of potential buyers. So who's still willing to step up and buy a house now, despite the constant talk of the housing bubble popping?

My theory #2: the majority of people do not really believe housing can drop appreciably. It hasn't happened in their lifetime;the modest decline in the early 90s didn't affect them at all. So their experience is: housing prices plateau but never really drop. And indeed, this has been the case for decade after decade in the Bay Area.

One of our close friends just bought a house for about $800,000. Like me, he saw the rapid rise in house values as a bubble; but unlike me, he has an infant, and he and his wife aren't willing to live in a flat for the next 4-5 years while the market drops. So he got a fixed-rate mortgage and bought the fixer-upper. (Yes, a fixer-upper in a desirable neighborhood still commands close to a million bucks.)

I don't think he's alone. If people can make the monthly nut, they just ignore the price tag and buy the place, reckoning any drop will mirror the early 90s--that is, a temporary decline of maybe 5% - 10%. But since they have a fixed-rate mortgage, who cares?

The key to this kind of confidence, of course, is a parallel belief that the U.S. economy will continue chugging along at near full-employment. Nobody worries about making that monthly nut--until one of the wage-earners loses their job. For most people, after two decades of largely uninterrupted growth and prosperity, to worry about a severe recession which could actually impact their income and lifestyle is akin to worrying about a meteor strike: theoretically possible, but so unlikely it isn't worth worrying about.

At this point I am reminded of the line from the Jackon Browne song, Road and the Sky: "Don't think it won't happen just because it hasn't happened yet." If foreclosures rise as I have posited (see the links in Housing Dominoes Fall), and if employment drops significantly in housing-related sectors, then those will be enough to tip the U.S. economy (and thus the world) into recession--never mind rising interest rates and $100 a barrel oil. Once people start getting laid off in non-housing sectors of the economy, then the see-saw will really start its downward move.

And then the value of one's house will start to matter because an increasing number of families won't be able to make the monthly nut that once seemed so affordable. And being unable to make the nut, they'll need to sell--and real quick-like. Only there will be thousands of other people in the same predicament--yes, gasp, even here in the endlessly prosperous Bay Area, home of the Limitless Family Trust Fund and backdated stock options.

Maybe I'm all wrong about this; we won't know for another year. In the meantime, here's another story on the topic:

Home prices inch up; rents rise, sales ebb High costs -- and interest rates -- cause more people to hit 'the affordability wall.'

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