Can We Call it a Bubble?
California just set a record for home prices, rising by almost 25% from the same time last year to a median of almost 760,000. Does that mean that the market is in another bubble? Price growth has certainly accelerated as 9 months of rebounding home sales has taken a tremendous toll on housing inventory. However, much of the increase in home prices can be explained by 3 factors: inflation, falling interest rates, and income growth.
Since the end of the 1980s, home prices in California have more than tripled from less than $200,000 for the typical single-family residence. However, interest rates during that time exceeded 10%. As interest rates have fallen, it has reduced the monthly burden on payments for each dollar borrowed, which has enabled would-be homebuyers to qualify for and borrow more money from the bank. Converting prices (which don’t account for rates) into monthly mortgage payments (which do), California is still more than 10% below its 2006 peak.
In addition, general inflation has increased both incomes as well as the cost of goods and services in California. According to the California Consumer Price Index (CPI) used to calculate increases in annual property tax bills under Proposition 13, prices have increased by more than 120% since the late 1980s. Converting monthly mortgage payments into inflation-adjusted mortgage payments allows us to compare mortgage payments from previous eras on an apples-to-apples basis as if prices had been in constant $2020 all along. This adjustment to what economists call “real” terms shows that mortgage payments are 33% below their all-time highs from 2007 and even 10% below where they were at the end of the 1980s.
Fewer households in California can afford the median priced home in the state because it has grown more unequal over time, but after considering interest rates, incomes, and overall inflation, mortgage payments on the median- priced home are not consuming larger shares of the incomes of those buying homes than is typical for California’s past.
California still costs more to own a home relative to other states and prices are still elevated relative to where they would be in a perfectly clearing market environment with no supply constraints. However, the price premium above that clearing price was only slightly higher than the pre-2000 average that has persisted in California for decades. Indeed, that premium is less than one-fifth the size that it was during 2007 when prices were more than double their market-clearing price.
That does not mean that the probability of prices softening in California does not exist. Indeed, recent price and rate increases make softer growth in the second half of 2021 more likely and C.A.R.’s forecast reflects those challenges. However, the downside risk of such an event is much smaller in magnitude than it was during the last cycle.
As always, prospective homebuyers should always purchase homes with their eyes wide open about both the potential risks of short-run market fluctuations, and the long-term benefits of homeownership. It is not 2008 all over again, just make sure the deal makes sense for your own personal economy.
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