The data in this story suggest that they are most out of line in San Francisco and Los Angeles. That is, the ratio of the median home price to the median income is highest in those two cities, and it is dramatically higher than in the other cities listed (where it also is high).
The price to income ratio exceed 8 in both cities. A normal ratio of price to rent is about 12. A normal ratio of rent to income is about 25 percent. So a normal ratio of price to income would be 3. To get to 8, you need, say, a ratio of rent to income of 40 percent and a ratio of price to rent of 20.
Some possibilities:
1. This is a sign that some time in the next few years home prices will fall in those two cities.
2. It is the rest of the country that is under-priced. People in other cities should be bidding up house prices where they live.
3. Perhaps there is some statistical fluke. Perhaps the discrepancies across cities go away if you break things down to individual neighborhoods. Note however, that the ratio of two medians is a harder statistic to skew than, say, the mean of income. So I doubt that this is the explanation.
4. Foreign ownership plays a larger role in those two cities than elsewhere, so that the inadequacy of median income is not a factor.
5. Supply is more constrained in California than elsewhere. Note, however, that I have a hard time specifying the demand curve that creates such a dramatic ratio of house prices to incomes.
I think that supply constraints are more likely to lead to volatility in house prices than to house prices that are permanently super-high relative to incomes. And in fact LA and SF have a history of high volatility.
I think property tax rates are a factor. Both CA and MA have low property tax rates as a percentage of market value:
http://www.tax-rates.org/taxtables/property-tax-by-state
That means a million dollar house in CA would have an annual tax bill of $7400. Here in Ann Arbor (a high tax locality in a high property tax state), we’re paying more than that on a house worth half as much. But if tax rates were lower, houses here would sell for more (the tax savings enabling potential buyers to spend more on P&I). And when mortgage rates are low as they are now, the effect is magnified (property tax savings will cover the interest payments on a lot of additional loan value).
Maybe not all incomes are created equally. Some are associated with high levels of wealth, the compensation structure of Silicon Valley and Wall Street is skewed to wealth generation over taxable income. Also, some incomes are less volatile than others. Incomes coming from the Educational-Health-Government (Cambridge, MA, e.g.) are more valuable than others.
What are the construction regulations like in those cities? There aren’t many high-rise apartments in SF.
I think the real issue – at least in SF – is low turnover of the housing stock combined with very high prices for a new and wealthier set of entrants who are nonetheless a small segment of the population
The new entrants in SF are tech workers who make good salaries and want to live in the city or buy homes in Silicon Valley. They make much more than the median income.
In California, Prop 13 leads to very low turnover of homes purchased, since you get to pay property taxes at the original rate. Combined with high home appreciation and a restrictive zoning environment, this means that someone who purchased 20 years ago has a massive financial incentive to stick with the same home. So the new entrants who want to buy homes are struggling with extremely low supply. Multiple offers are common.
In SF, rent control serves a similar purpose of pushing up market rents while reducing the median rent people actually pay.
In both cases, Forbes is measuring the market rent, but the cost of housing the median income pays for is much, much lower priced.
In other words, outsiders/newcomers are getting a much worse deal than insiders/oldtimers who have used their majority in government participation to set the zoning, rent control, and tax regimes in their favor.
Yep, this would be a big part of my answer. The median price of an available home or market rent is very different from the average tax basis for property tax or average rent paid. It’s unaffordable for all but the wealthiest newcomers, but long time residents do pretty well (so long as no landlord does a conversion.)
Are the home ownership rates lower in those cities than elsewhere? The median price to median income ratio for a city can be higher if fewer people actually own their own homes. In that case, real estate would be disproportionately owned by the wealthy few and rented out to the lower rungs.
At least in SoCal, yes. LA County has a homeownership rate less than 50%. See here: http://www.doctorhousingbubble.com/wp-content/uploads/2015/06/california-county-homeownership-rates.png
And at least across the LA area in recent times, it seems like there is a massive skew towards the higher priced areas. The price premium to get into a SFR in a “good” school district (e.g. out of the LAUSD nightmare) appears to have skyrocketed. Also, a lot of anecdotes being tossed around about foreign buyers in the San Gabriel Valley (e.g. Arcadia becoming the Chinese Beverly Hills).
So, basically, a confluence of every one of Arnold’s factors except 2. I’ve watched two of these cycles play out in SoCal, and I don’t think this time is any different.
Ryan Avent’s book The Gated City and Matthew Yglesias’ ebook The Rent is Too Damn High argue for a variation of 5. Rapid growth and massive regulatory constraints on supply. The thought experiment example would be if Detroit in the 1950’s during the car boom tech growth phase would have cut housing supply growth regulations. Population growth in LA and SF should be huge.
Not clear why you didn’t cite them in part 5. Do you agree? Disagree? Not read? Or are you making a more subtle point against what they’re saying I missed? Either way would be very interesting if you contrasted your views to theirs on this topic.
Also, to answer Urstoff’s question on construction: most areas of the SF Bay Area is tightly regulated to allow only low-rise buildings. Also, building permits that satisfy zoning requirements are not “of right” but need to be approved by neighborhood associations – which is usually a mechanism for extracting concessions from developers in some way. It’s usually a combination of money and smaller buildings than are permitted by zoning.
Here’s a good map of height limits in SF, theoretically the densest part of the Bay Area. In the vast majority of the city, you can’t build higher than four stories (the yellow area):
http://www.quora.com/Do-San-Francisco-zoning-laws-that-prevent-neighborhoods-from-building-tall-buildings-for-more-people-to-live-in-hurt-its-residents-and-drive-up-rent
LA+SF might also have:
6. higher occupancy (more people renting just a room or cramped multi-unit and unable to afford renting a whole house)
7. more undeclared cash income (medical marijuana ecosystem + illegal immigrant labor is commonplace and so cash labor is normalized)
8. more rent control + section 8
9. decades-ago prop 13 incumbents who won’t move to increase their income
10. more vacation rentals / vacant (for uber-rich) 2nd homes
(all speculation)
11. LA Only add a weather premium. Can’t buy this weather anywhere else. It is the only reason I stay here.
Land use restrictions are the driver of the extended relationship in coastal CA and the more desirable/land-use-restricted portions of the Northeast/Mid-Atlantic. Also London et al.
In areas with long-term unconstrained supply (limited building restrictions) home prices will oscillate around replacement cost (including land development costs), which will rise over time based on: trend change in square footage per home + raw material and labor inflation – trend homebuilding total factor productivity.
In areas with long-term constrained supply (extensive building restrictions) home prices will oscillate equilibrium affordability to the marginal buyers, which will rise over time based on: trend wage growth and secular changes in interest rates/financing-terms.
Since trend wage growth runs higher than trend inflation in housing replacement cost, home prices and imputed land values in hard-to-develop areas will tend to rise over time relative to place where home prices are more bounded by replacement cost.
Also, note that a historically low interest rate environment (and availability of very low spread and long term fixed rate mortgages) has a much more profound effect on wage-related affordability (relevant to land-scarce markets) than on replacement costs (relevant to readily developed areas).
I’m ignoring hedonic/quality adjustments.
There is no national average; rules of thumb don’t apply. Prices are driven by congestion, permanently, or until the urban area declines and people move away. Once commuting beyond an urban area becomes prohibitive, prices will rise with income, and while rents will be high relative to incomes, they will be low relative to prices because of the strong investment value of property, prices rising to lower the net dividend flow to nil, or slightly below nil since these are tax shelters. More productive than complaining about zoning would be promotion of rapid, efficient, long distant commuting.
In San Francisco, over 70% of rental units are rent-controlled. This allows a lot of low-income people to live there, pushing down the median income. Meanwhile, there are no price controls for home sales, and these are pushed up by the shortage of market-rate units.
If you excluded everyone in a rent-controlled unit, I think the price-income ratio would look more reasonable.
Maybe the value of living in SF or LA to those who choose to live there makes up for the higher cost of housing.