How Helpful is the Price-to-Income Ratio in Flagging Bubbles?

by Rocio Sanchez-Moyano
Research Assistant

With the continued growth of house prices across the country, talk of a housing bubble is beginning to reappear in the headlines. House price-to-income ratios are often used to indicate a bubble, as prices have historically had a relatively stable relationship with incomes (both mean and median).  In the US, nationally, the price-to-income ratio remained relatively stable throughout the 1990s.  It began to increase around 2000 and surpassed its long-run average of 3.65 by 2002 (Figure 1).  The national price-to-income ratio continued to increase in the mid-2000s, reaching a high of 4.63 in 2006 before rapidly declining in 2007 and 2008 and eventually hitting a low of 3.26 in 2011.  The classic bubble shape is clearly visible in this trend.  Recent price gains, viewed in this context, do not seem to indicate the return of a bubble; price-to-income ratios today match their early 1990s rates and still have some room for growth before reaching their long-run average.  (Click chart to enlarge.)

Notes: Prices are 1991 National Association of Realtors® Median Existing Single-Family Home Prices, indexed by the FHFA Expanded-Data House Price Index.  Incomes are median household incomes.

Sources: JCHS tabulations of FHFA Expanded-Data House Price Index;  US Census Bureau, Moody’s Analytics Estimates.

However, despite the seemingly straightforward relationship between house prices and incomes in Figure 1, this indicator can be difficult to interpret.  To start, many data sources are available for measuring prices.  One used frequently is the National Association of Realtors ® (NAR) Single-Family Median Home Price as it is widely available for many metros and provides an actual house price (rather than an index showing change in values) that can be compared to income levels.  The disadvantage to this measure is that NAR house prices also capture changes in the types of units that are being sold over time and so does not reflect how the value of the same home changes.  Repeat sales indices, like the Federal Housing Finance Authority’s (FHFA) Expanded-Data House Price Index, which was used to produce the figures in this post, are designed to take into account changes in the values of homes themselves by tracking sales of the same homes over time.  However, the FHFA index can be more difficult to interpret since, as an index, it does not provide information about current prices.  Price-to-income ratios using this data must peg the index to a starting or ending house price.

Furthermore, identifying bubbles or other price anomalies from price-to-income ratios can be difficult because it is not clear what is an appropriate baseline value of the measure for comparison.  Even in the aggregate US case, where the ratio did not fluctuate more than one percent in either direction for much of the 1990s, the linear trend is not flat and the long run average is above the 1990s levels.  This becomes even murkier when observing trends at the metro level.  Some metros, like Dallas, had stable price-to-income ratios over the last two decades (Figure 2).  Dallas did not experience a significant bubble in the mid-2000s and its long-run average mirrors the linear trend.  In other metros, like Phoenix, the boom-bust period led to significant fluctuations in the price-to-income ratio after having been relatively stable in the 1990s.  If the 1990s levels are to be considered normal for Phoenix, then current price-to-income ratios remain below average and recent growth in prices can be considered a return to normal after an overcorrection.

For other metros, the price-to-income trend is more difficult to interpret.  Ratios in Cleveland are well below their long-run average, but the historical trend has been drifting downwards, so ratios in recent years could be indicating a reset of the ratio in Cleveland to lower levels.  At another end, San Francisco has experienced a wide range of price-to-income ratios in recent history.  Price-to-income ratios boomed in the late 1980s, decreased throughout much of the 1990s, and then surged through the mid-2000s.  Compared to its long-run average, ratios in San Francisco are above historical norms, but, when the historical trend is considered, prices can continue to increase before they appear “too high.”  Finally, if a fundamental relationship exists between prices and incomes, it is unclear why the ratio can vary significantly from metro to metro.  The national average is around 3.6.  In the metros observed here, Cleveland and Dallas both have historic averages below 3.0 while San Francisco’s is double the national average. (Click chart to enlarge.)

Notes: Prices are 1991 National Association of Realtors® Median Existing Single-Family Home Prices, indexed by the FHFA Expanded-Data House Price Index.  Incomes are median household incomes.

Sources: JCHS tabulations of FHFA Expanded-Data House Price Index;  US Census Bureau, Moody’s Analytics Estimates

Given this variation, what can we make of the price-to-income ratio?  On a national level, this ratio does a relatively good job of identifying substantive shifts in the market.  In the aggregate, there appears to be a “normal” price-to-income ratio and prolonged deviation from this trend can signal an underlying shift.  However, on a metro-by-metro level, where it can be difficult to identify an appropriate baseline value, long-run historical context is necessary to interpret point-in-time estimates.  In markets like Dallas and Phoenix, historical trends are consistent enough that it can be useful to compare the current ratio to past ones.  In others, like Cleveland and San Francisco, the price-to-income ratio on its own is not especially helpful since there is no clear way to identify a “normal” price-to-income ratio.

Boston's Housing Challenge: Affordability, Availability

Housing availability in Boston has been a particular passion for outgoing Mayor Thomas Menino, who recently unveiled an ambitious plan to build 30,000 homes in Boston by allowing taller structures with smaller units, selling public land to developers at a discount, and using subsidies to spur development of more affordable housing.  Last week, Joint Center managing director Eric Belsky, who served on the Housing Advisory Panel for the plan, joined other housing experts on the local NPR program Radio Boston, to discuss the mayor's plan and Boston's challenges.

Listen to the Radio Boston conversation online.

The Metropolitan Revolution

by Bruce Katz
Guest Blogger

Next Wednesday, September 25, I will be coming to Harvard to share a message: there is a Metropolitan Revolution underway in this country.

While the national economy continues to suffer the lingering effects of the Great Recession—with nearly 10 million jobs needed to make up the jobs lost during the downturn and keep pace with labor market dynamics and more than 107 million people living in poverty or near poverty—the federal government is mired in partisan gridlock and ideological polarization, leaving local and metropolitan leaders to pick up the slack.

In many ways, this transfer of responsibility is not only a cyclical event but also a structural change, given the harsh realities of the shifting federal budget. With a rapidly aging national population, mandatory federal spending on health care and retirement benefits is projected to rise by $1.6 trillion annually by 2023.  This will inevitably squeeze federal spending on critical investments around education, infrastructure, housing and innovation. The result will be a U.S. governance structure that looks very different in a decade: Washington will do less; local governments and metropolitan networks will do more.

To make it through this fiscal resort, we need to rethink power in America. Metros will lead on policy innovation; the federal government (and even state governments) will follow.

The good news is that smart city and metropolitan leaders aren’t waiting for national solutions to local problems. Across the nation, in metros as diverse as New York, Houston and Denver, Portland and Detroit, Los Angeles and Cleveland, leaders are doing the hard work to grow jobs and make their economies more prosperous: investing in infrastructure, making manufacturing a priority again, linking small businesses to new investors and global markets, giving workers the skills they need to compete.

A new metropolitan playbook defines the Metropolitan Revolution:

First, cities and metros are forming broad based networks to co-design and co-produce solutions. The unique advantage that metropolitan areas have over states and the national government is that they are networks of leaders, rather than hierarchies of government officials. Successful metro-level initiatives incorporate broad input and support—from business and civic leaders, heads of universities and philanthropies, as well as elected officials. 

Second, city and metropolitan leaders are taking the time to understand the starting points of their disparate economies and set distinctive visions based on their analysis. The Great Recession reminded us that metro areas perform different functions in the global economy depending on what they make, the advanced services they provide, what they trade and which cities and metros they trade with. What makes Denver a powerful metropolis on the global stage is different from what propels Detroit; the same for Portland, Pittsburgh and Phoenix. 

Finally, city and metropolitan leaders are “finding their game changers” -- designing, financing and delivering transformative economy-shaping solutions that build on their distinctive assets and advantages. The Applied Science Districts in New York City. State-of-the-art transit in Los Angeles and Denver. A new export strategy in Portland; smart manufacturing initiatives in Northeast Ohio; successful efforts to integrate immigrants in Houston.  Even a burgeoning Innovation District in Detroit.

Cities and metropolitan areas will do more because they can. 

The United States is the world’s quintessential Metropolitan Nation.  All 388 metropolitan areas house 84 percent of the nation’s population and generate 91 percent of the national GDP. The top 100 metropolitan areas in the United States alone sit on only 12 percent of the land mass of the country but house 65 percent of the population, generate 75 percent of the GDP. They also concentrate and congregate disproportionate shares of the assets that the nation needs to compete globally: modern infrastructure, skilled workers, advanced industry firms and advanced research institutions.

The United States also devolves more fiscal responsibilities to cities and metropolitan areas (and their states) than other countries. Despite the attention given federal efforts like No Child Left Behind and Race to the Top, local and state governments already account for over 90% of total government spending. Despite the focus on still unrealized proposals like a National Infrastructure Bank, states and localities already account for over 70 percent of transportation infrastructure spending and are the driving force behind such investments in such asset categories as roads, transit, rail, ports, airports, water and sewer and, of course, urban regeneration and basic municipal services.   

Make no mistake: cities and metropolitan areas (and a mixed group of states) will drive strategic investments in education and infrastructure going forward, and they already are. San Antonio’s recent passage of a ballot initiative—Pre-K for SA and Detroit’s corporate and civic support for the M1Rail along Woodward Corridor—are only the latest examples of communities (broadly defined) stepping up to get stuff done.

Yet it is also likely that cities and metropolitan areas will lead in areas traditionally left to the federal government, like investments in basic and applied science and affordable housing. The recent sequestration of federal funding for such traditional federal responsibilities as the National Institutes of Health and public housing sent a strong signal about how unreliable our national government has become. The response will be growing state and metropolitan support via the ballot box for basic and applied research (e.g., California’s $3 billion Stem Cell Research and Cures Initiative) and growing local and metropolitan innovation on the affordable housing front via inclusionary zoning, public private partnerships and local housing trusts capitalized through real estate transfer taxes.

The bottom line is this: the health of the United States should never be defined by what happens in Washington, D.C. Our metropolitan areas are the engines of our economy, the centers of global trade and investment and the driving forces of national competitiveness and prosperity.  In the coming decade -- in this century -- they will be the vanguard of policy innovation and national progress.

Bruce Katz is a Vice President at the Brookings Institution, co-director of the Metropolitan Policy Program, and the co-author of The Metropolitan Revolution (Brookings Institution Press, 2013).  He will speak at the Harvard Kennedy School on Wednesday, September 25 at 7pm (Belfer Building, 79 JFK Street, Cambridge, MA, Starr Auditorium). The event is free & open to the public.

Keeping an Eye on Trends in Household Growth

by Chris Herbert
Research Director

While home prices and construction levels are on the rise, the most recent estimates suggest that the rate of household growth slowed during the first half of 2013 from what had been promising indications of a rising trend through 2012 (Figure 1).  The rise in household growth last year had been a key source of optimism that the housing recovery was being built on the solid ground of expanding demand for additional housing.  The latest indication of a possible slowdown in household growth raises a cautionary flag that we have not fully turned a corner on the slowdown in household formation that began during the Great Recession. It also raises questions about how long a recovery in the single-family for-sale market can be sustained absent greater growth in homeowner households.

Note: Annualized growth is change in trailing 4-quarter average household estimate from  previous year; year-over-year growth is change in quarterly household estimate from previous year.  Source: JCHS tabulations of US Census Bureau, Housing Vacancy Surveys.

The source of the recent estimates is the quarterly Housing Vacancy Survey (HVS) conducted by the Census Bureau, which in addition to providing data on vacancies and homeownership rates also provides the timeliest available estimates of the number of owner and renter households.  The HVS quarterly estimates are somewhat volatile, but this volatility can be dampened by examining averages of the previous four quarters, which is how the annual HVS estimates are produced. There are also non-trivial differences in the count of households from this survey compared to the decennial census for reasons that are not well understood. Over the course of the past decade household growth estimates from the HVS were on the order of 15 percent below what the decennial censuses indicated, suggesting there is a downward bias in household growth from this survey. But while there are questions about the accuracy of the overall count of households from the HVS over time, there is still reason to believe that the survey is useful as an indicator of the latest trends in the direction of household growth.

The HVS data for the second quarter (Q2) of 2013 suggest that not only was the acceleration of household growth reported for 2012 less than originally reported, but also that growth has slowed in the first half of 2013.  Back in 2012, HVS data were showing that annual household growth in the US had rebounded significantly, to a level of 980,000 for the year after averaging less than 600,000 over the previous five years.  With the Q2 2013 data release, however, the HVS also revised its 2012 annual household growth estimate down by over 100,000 households to a less robust level of 857,000. 

On top of the downward revisions to 2012 growth, HVS data now also show that in the first quarter of 2013, the year-over-year pace of household growth plummeted back to the lowest rate since mid-2010, down to 403,000. While the Q1 number could have been a statistical blip, the Q2 number shows household growth still just 746,000 - well below last year’s annual pace.  Taking these two quarters into account, the most recent annualized household growth rate is just 751,000. Given this pace household growth will have to average nearly 1.2 million in the second half of the year just to match last year’s reported growth.

The Q2 HVS data also show that the homeownership rate failed to reverse its downward course in the second quarter of 2013.  While the Q2 rate of 65.0 percent is unchanged from Q1, it is still 0.5 percentage point below the homeownership rate from a year ago.  Of particular concern is that behind the homeownership rate decline is a contraction in the number of homeowners (Figure 2).  Based on a 4-quarter moving average estimate of households, the number of homeowners was down by 178,000 in the second quarter of 2013.  This contraction is on top of newly released revisions to historical HVS data that show fewer homeowners in 2012 than originally reported. In all, the number of homeowners in HVS is 1.5 million below its peak at the start of 2007.

Note: Household estimate is 4-quarter trailing average.

Source: JCHS tabulations of US Census Bureau, Housing Vacancy Surveys.

These trends suggest that recent gains in home prices and single family home construction have been driven more by a restricted supply of homes for sale amid demand from existing owners rather than by growth in first-time homebuyers adding to the number of owners.  With continued weakness in household growth and declines in the outright number of homeowners, the latest HVS data suggest that for-sale housing markets may face challenges to a sustained recovery if the inventory of homes for sale expands but the number of households looking for homes does not.