SoCal Median Prices: What Do They Really Tell Us?

The LA Times had an interesting article a couple of days ago. It noted that median home prices were starting to come into line from an historical perspective with median incomes. Two housing analysts had somewhat divergent views of what this means.

First, here is the chart they posted:

Chart: Affordability in California

There is virtually no explanation as to what metrics they used to arrive at their calculation of what a home should cost based on a given median income. So we will just have to reluctantly take them at their word as we work through the rest of this.

The first analyst, Christopher Thornberg, thinks that prices are in fact below the level that they need to be to spark buying.

Thornberg estimates the current median home value in California is $250,000. But wages are high enough — and interest rates low enough — that a median value of $290,000 would match historical norms, he said.

“If you’re looking for a long-run opportunity, real estate is getting to that point,” said Thornberg, who was an early predictor of the housing crash.

But it’s not at that point yet.

Thornberg believes home prices have another 25% to 30% to drop. They may be historically low, but “in the past four or five months, unemployment has been through the roof,” Thornberg said.

Fearing for their jobs, many potential home buyers are putting off a purchase. Others simply can’t buy anything because they are already out of work.

Thornberg forecasts that California home prices will fall until the middle of 2010, when they will begin to slowly creep up.

Again, he doesn’t tell us how he models this so it’s hard to place too much credibility in his statements. The fact that he’s talking about buying opportunities makes one wonder if we aren’t into the world of real estate hype once more.

The second analyst, John Burns, has a different take.

“They’re still not as affordable as they were in 1995 and 1996, and I think there’s an almost certainty prices will keep falling,” Burns said.

Even after the economy exits the recession, people will continue to lack the confidence to buy a home, Burns said. “It’s bubble psychology. People believe when something happens for three, four or five years in a row, it’s likely to keep happening. It happens in boom times as well.”

Burns predicts home prices in the Los Angeles area won’t rise again until 2012.

An analysis by Burns shows that the last time Los Angeles home prices dropped below their historical average relative to incomes, in 1992, they kept falling until 1997 and didn’t return to their 1992 level relative to incomes until 2002.

OK, this guy sounds a little bit less like an industry spokesman and no discussion of how they got the numbers but a little more in tune with buyer psychology and a bit deeper look at historical trends.

Finally we have Aarchan Joshi an opthalmologist who is thinking of buying in an upscale neighborhood. He’s running his own numbers.

That’s why Aarchan Joshi, a 40-year-old ophthalmologist who lives in north Redondo Beach, is putting off a move to Manhattan Beach. He could afford to move now but thinks “there’s a big disconnect. The more affluent areas are really just beginning” their price declines, he said.

A bit of an armchair economist, Joshi said he figured Manhattan Beach’s median home price is 13 times its median household income. “It’s completely unsustainable,” he said.

“My range would be when it gets to seven times or eight times income, that would trigger me to seriously look at buying a home,” he said. His guess is that will occur around 2012.

This guy has identified the flaw in the logic of the other two. The median home price number is distorting the calculation of affordability. Joshi avoided the trap by focusing on one neighborhood and developing statistics specific to that micro-market. The other two are making sweeping statements that will only by accident be right. Like a broken clock which tells the right time twice a day. If their median income and cost numbers happen to fit well with a given micro-market they will be on the money but they tell you nothing about a housing market as big as Southern California.

The median home price number in California and most other areas that have suffered significant foreclosure activity has been badly skewed by the distribution of sales. At the bottom end of the market sales are almost robust as first time home buyers and investors scoop up bargains. The middle and upper ends of the market are practically devoid of sales, and foreclosures are just beginning to pick up steam. Since the median price is calculated on closed sales, it naturally shows a marked decline given the distribution of sales.

A young professional working in, say Los Angeles, who might be earning the median income is not advantaged by the fall in the macro median price. It means little to him if prices have fallen dramatically in the Inland Empire since it is not a practical location. What does matter is the micro median price in neighborhoods that do make sense and in that case the picture isn’t as attractive.

Don’t get me wrong, I do consider the fall in median prices a positive. It’s just that pundits are trying to read too much into a number that is badly distorted at this time. There is a lot more pain and adjustment that will have to take place before we get back to a truly healthy real estate market.`

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