Friday, April 07, 2006

California Dreaming?

A very straightforward but valuable (IMO) way to see if house prices are in line with fundamentals is to compare salaries with house prices. Median house price is usually compared with Median Salary. A study(PDF) from Demographia took a good look at this ratio for cities in the US, Canada, UK, Ireland, Australia and New Zealand. The results show that six out of the top ten most unaffordable places within these countries are in California. Topping the list, LA, with a ratio of 11.2. I.e. Someone earning the median wage in LA would need to borrow 11.2 times their income just to afford a median-priced house.

1 US Los Angeles
2 US San Diego
3 US Honolulu
4 US Ventura County
5 US San Francisco
6 US Miami
7 Australia Sydney
8 US New York
9 US Riverside
10 US San Jose

To put this in perspective, anything over 3 (i.e. median house costs 3x median salary) is considered unaffordable. San Jose for example has a ratio of 7.4, so if prices halved, it would still be considered unaffordable.

California is nice, but is LA really so much better than say, Austin, where the ratio is only 2.8? No wonder California has a net out migration of people. Most people admit there are at a minimum some localized real estate bubbles in the US. Surely the list above has to represent the biggest of these. For LA to be affordable, houses would have to loose nearly 75% of their value. I’m not quite sure things will go as far as that, but I think California housing is set for a fall.

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