As we’ve already discussed the Case-Shiller index and mortgage metrics in order to assess the health of the housing market, I would like to take a slightly different approach: affordability. In order to gauge affordability in the housing market today, I will analyze two different ratios—the ratio of price to income, and the ratio of price to rent. We will define the ratio of prices to income as the ratio of house prices to median household incomes compared to their long-run average. Likewise, we will define the price to rent ratio as the ratio of house prices to annual private-sector rents compared to their long-run average.
The Economist has pulled price information for properties from Zillow in order to illustrate these ratios for some of the nation’s biggest cities. I will focus on the nation’s two biggest metro populations: New York and Los Angeles, and the US average, for simplicity’s sake. As you can see in the figure below, the price to income ratio for all three of these locations is higher than the long-run average (represented by the horizontal red line = 100), indicating that homes today in these areas are less affordable compared to income than the historical average, especially in LA and New York. In terms of the price to rent ratio, we see from the price to rent graph that New York and the US average is below its long-run average, however, LA is above its long run average. This illustrates that the price to rent ratio in the US, on average, is on-par with fair value, however, in some metro areas, like LA, home prices are much less affordable than annual private-sector rents, in terms of long-run averages.
The two graphs demonstrate the growing disparity between housing markets in the US, in terms of geography. Even though home prices in the US, on average, are close to fair value; some metro areas like LA are no where near the average long-run affordability levels when compared to income.