US Home Prices Have Softened Somewhat. How Much Lower Should They Go?

Prices of new homes sold in the US have softened somewhat.

As of August 2019, the average prices of new homes sold in the US have dropped 2.2%, from $323,125 in 2018 to just $316,075 today. Incomes have also risen. We estimate the median household income to be $65,074 in 2019, up 3.0% from $63,179 in 2018 and up 6.44% from $61,136 in 2019. As a result, the house price to income ratio now stands at an affordable 4.86 times income, down from its recent peak of 5.26 times income in 2017.

But house prices are still a long way from affordable. The current house price to income ratio is more than one standard deviation above the long-term mean of 4.23. The same holds true for existing homes and all homes both new and existing.


 

Home Type	2019 Median Sales Price	2019 Median Household Income (Estimated)	2019 House Price to Income Ratio (HPI)	Mean House Price to Income Ratio (Mean HPI)
New Homes	$316,075	$65,074	4.86	4.23
Existing Homes	$268,513	$65,074	4.13	3.73
New and Existing Homes (Weighted Average)	$273,859	$65,074	4.21	3.81

So how much further do home prices have to fall to become affordable at current incomes? About 9.4% for all homes, from the current price of $273,859 to $248,160. The drop in new home prices will have to be even steeper: almost 13%.

Conversely, if home prices remain flat, how much further do incomes have to rise to reach their long-term affordability? For all homes, this is around 10.4%. To afford a new home, incomes have to rise 14.9%.

If incomes rise by the current rate of 3.0% a year, it will take 3-5 years before home prices hit their long-term affordability ratios. If prices continue to drop at the current rate of just 2.0% a year, it will take much longer: 5-7 years.

We could be in for a long wait.

US Real Estate Market: This is a Slowdown and Not a Crash

US Home Sales Volumes (both New and Existing Homes) are down 3.82% since their peak in 2016 even as their median sales price reaches new highs.

This trend is borne out by the market for existing homes where prices are still going up as volumes dip, indicating fewer and fewer people can afford the higher home prices.

The opposite trend is true in the market for new homes. Volumes are up while prices are down a mere 2.60% from their peak in 2018.

But since the market for existing homes is almost eight times the size of the new homes market, the existing homes market trend is the dominant one.

Are we in for another housing crash. In a word, no. Not yet. This is just a slowdown and not a crash.

How Elevated Are US Home Prices?

How elevated are US Home Prices?

Try very elevated. But not too much. Yet.

Median New Home Prices in the United States have been registering at more than five times the Median Household Income for the past four years. They are almost two standard deviations away from the mean ratio of 4.19 times income - a level which would place the ratio squarely in bubble territory. Right now, there is only a 3.4% probability that the market could go higher, assuming a normal distribution. These levels are slightly above the 5.06 times income ratio at the peak of the last US housing bubble.

Source: St. Lous Federal Reserve

One reason why this bubble hasn't popped yet is that the phenomenon is largely confined to new homes. The median sales price of existing homes have gone up and its house price to income ratio now stands at an estimated 4.01 times in 2017. Elevated for sure, but not quite the euphoric levels of 4.74 times income registered in 2005. Another reason is that sales volumes for new homes represent only 11% of total home sales.

Source: Federal Reserve

Nevertheless, on a blended basis, the ratio of house prices to income stood at an estimated 4.14 times. In contrast, the peak ratio was 4.81 times income in 2005. So the US real estate market has yet to surpass the unaffordability levels of the last housing bubble.

Read:

The US Housing Bubble Has Been Fully Reflated

US House Prices Have Climbed Upwards But So Have Incomes

US House Prices Have Climbed Upwards But So Have Incomes

In our last post, "The US Housing Bubble Has Been Fully Reflated," we discussed how US House Prices have entered bubblicious territory because because median US House Prices stood at 5.63 times median household income - two standard deviations away from the long-term average of 4.24 times median household income.  Based on what I remember of my statistics classes, the probability of this taking place is exceptionally low: only 2.5%. Since then, house prices have continued to increase:

In 2015, house prices, as evidenced by the S&P/Case-Shiller 20-City Composite Index, increased by 5.03%, but so have incomes. Real Median Household Incomes increased even faster in 2015, by 5.33% to reach $56,516 at the end of 2015:

As a result, median new home prices are now only 5.11 times median household incomes in 2015, slightly less than two standard deviations above the long-term average of 4.24 times. Prices are still elevated but no longer in true bubble territory.

Source: St. Louis FRED

The US Housing Bubble Has Been Fully Reflated

Last week, I came across this chart from Barry Ritholtz's BloombergView column "Confusion About the Financial Crisis Won't Die":





According to Barry Ritholtz:

"the ratio of home prices to income began to tick up in the early 2000s. By 2002, it was approaching its 1980s highs. It was a standard deviation away from the norm by 2004, and it reached at 2 1/2 times the norm in 2005. Housing, as a few of us observed long before the financial crisis bloomed, was a debacle about to happen.

 The housing boom drove employment in construction, mortgage brokerage, home furnishings and durable goods. We even had a bull market in real-estate agents. People pulled cash out of their homes at furious rates to fund renovations at first, then big-screen televisions, automobiles and vacations. The broader way to understand this is that wages were stagnant, inflation was starting to rise and rather than accept a drop in living standards, people used home equity to maintain consumption."

I noticed that the chart from Ned Davis Research only covered the period from 1977 to 2010. Home Prices, as indicated by the S&P/Case-Shiller 20-City Composite Home Price Index, have increased substantially since then.

So what does an updated version of the Ned Davis Research Chart look like right now? It looks like this:

The ratio of Median New Home Prices to Median Household Income has surpassed the highs of the last housing bubble and is once again more than two standard deviations above the norm - clearly unsustainable.  Housing is once again a debacle waiting to happen.