Most of us still remember the housing crash of 2008 – vividly. Housing prices, driven by ever-more-creative financing and frenzied demand skyrocketed higher and higher in a positive feedback loop that everyone knew would crash one day, but few knew where to jump off. Today’s market feels “frothy” (as Alan Greenspan would say) like the market running up to 2008. So are we in a new housing bubble?
Not according to a new study conducted by the San Francisco District of the Federal Reserve. To examine this, economists Reuven Glick, Kevin Lansing and Daniel Molitor looked at two key measures that give us some insight into the underlying components of housing values.
The Mortgage Debt to Income ratio tells us how the cost of carrying homes on the aggregate compares to incomes as an aggregate, and thus speaks to the affordability of homes at any given point in time.
The House Price to Rent ratio speaks to what I call the foundational monthly value of housing – what renters must pay to occupy the space each month. This speaks to the investment value of a home, measured by monthly cash flow.
If you look to the chart on the right, you’ll see that the amount of income each household had to commit to mortgage debt every month rose precipitously during the early 2000’s all the way through 2008. Logically, at some point there is a limit. You can only pay so much of your income towards your monthly mortgage payment. When we hit that limit, housing prices simply have to level off or go down (unless incomes rise precipitously too.)
Note, however, that since 2008 the ratio has been in steady decline. While there are many factors, certainly a good portion of it is due to lower interest rates, and therefore lower mortgage payments. A lot of the toxic loans (which tended to have much higher payments once they adjusted or re-casted) were foreclosed on, modified, or refinanced, all of which also helped alleviate high aggregate monthly mortgage debt.
In the same graphic you’ll also see that the price of homes relative to the rental value also spiked leading up to the financial crisis. This peaked and started downward earlier primarily because rents began to rise after many years of stagnation. This ratio didn’t really start moving up again until home prices started spiking in 2012.
Both of these factors are significantly below their peak in 2008 at this time. By these measures, housing values do not appear to be inflated at all – yet.
What this means is that housing prices – relative to their monthly rental value and relative to the income required to support them – are at about the same price level as they were in 2002. Without “creative” (OK, stupid, toxic, insane) financing to help support rising values we won’t (thankfully) reach the same relative levels that we did in 2008.
Housing prices are driven by many factors, but one of them is the desire for housing. When home buyers feel that they need to “get in at any cost” housing prices can get frothy. When home buyers feel that housing might not be a good investment they stay away in droves, and relative values decline. (See chart again, 2008 through 2012.)
Desire for housing has certainly come back (how quickly we forget about the crash.)
However, while the perception that housing is a good investment again has obviously made a comeback, Millenials are struggling with weak income and high student loan debt, and have famously turned their backs on home ownership (for now.) Further, interest rates are bound to rise sooner or later, and when they do that changes the Mortgage Debt to Income Ratio, holding prices down a little.
What this tells me – and predictions are risky – is that values relative to rent and income are about right today. As long as income and rents continue to rise values should rise at about the same pace. Because there are still so few listings values may outpace incomes for a short while, but this would be mitigate by rising interest rates.
If these things are all true, housing prices should basically keep pace with inflation from now on, and inflation is very mild. Have we returned to “normal?”
The full article can be read here.