Is price the wrong indicator?

[Ash Housewares]

Long time lurker, first time poster.

I have noticed that most of the analysis on this site relies on (inflation adjusted) home prices when attempting to quantify the size of the bubble. Or, when you want to get a more sophisticated result, the inflation adjusted price per square foot. Using these data, the typical post will read something like “houses are sooooo overpriced- look at the change in the home price/income ratio!!!” or something similar. I think this is a flawed analysis because it ignores the changes in interest rates over time. The two are inextricably linked- more money paid on interest means less for principal- and vice versa.

I haven’t fully thought through what a better way to measure the bubble would be, but the first thing that springs to mind is something like “monthly median mortgage payment divided by median income”. In other words, an affordability index that is based on the total cash outlay, rather than just price or price per square foot. It just seems we are ignoring half the picture when we examine price without simultaneously taking into consideration interest rates. Am I missing something here?

[Chris Scoreboard Johnston]

Chris Johnston

I completely agree, measuring price to predict price is a notorious mistake in the world I live in. It is clear to me that the interest only calc for mortgages needs to be substituted for the 30 yr P+I as the base affordability measure. These loans have been around for a very long time, and are not going away, so figuring payments based on those I think has more merit. So maybe 20% down and then Interest only on the 80% etc.. The 100% financing I am not too sure about longevity wise. This also needs to be used in the rent to own ratios in my opinion.

Ratios like you speak of have been written about, even by that pathological liar, Lereah. I do not know what the best ratio would be, but I think research in that area is prudent. I do not have time to do it. I read an article recently about a gal who created her own P/E types of ratios and used them to buy and sell homes successfully. There are some great researchers in here, so maybe somebody can take this one on.

[drunkle]

you could probably use the simple relationship, 1$x1R = 2$x2R. meaning, the first loan amount 1$ times the first interest rate 1R is equal to a different loan amount 2$ times a different interest rate 2R. eg., 200k x 6% = 171k x 7%.

people aren’t missing this point, they frequently mention that if interest rates go up, home prices will come down. the converse is obviously true. the problem is that despite the low current interest rate, home prices are still over inflated:

100k @ 10% = 166k @ 6%. and not 500k.

edit: i’m tired of hearing about “inflation adjusted prices”, it’s nonsense. my wages dont get “adjusted for inflation”, it is what it is. if i get a raise, i dont call it “inflation”. justifying increases in home prices due to inflation is senseless since nobody else is calculating their wages in inflation adjusted terms. homes that become out of reach for most americans due to “inflation” aren’t inherent more valueable; they’re worth what people will/can pay for them, inflation or not!

[bob007]

inflation is real. If you buy a home in Dallas for 100k in 1982 and you sell its for 200k in 2002 you made 100k in profits. Accounting for inflation it is a lousy ROI.

[drunkle]

and if you didn’t sell it at all, you’d have a home to live in, paid in full.

accounting for “inflation”, it is… still your home!

[L_Thek_onomics]

The most accurate indicator of housing bubble, when the moron, who never had a dime, start to educate you about real estate investment. Another fairly accurate indicator, a couple with 125k yearly income can realisticly afford a “starter” condo in the ghetto if they stick to the traditional fixed 30 year mortgage.

L Thek

[lonestar2000]

I think one of the best indicators is median price vs median income.

For instance, I make the median income for my area, but the median priced home is nearly 8x that much.

Considering the traditional, 30 year fixed rate loan products (which is the only one worth considering imho) — which states that you can borrow roughly 3x your yearly gross income — prices are thoroughly out of whack.

If the average Joe can’t afford the average house then we have a problem.

[lonestar2000]

Oops, didn’t meant to post twice. 😀

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