Is This the Top of the Market? Part 2

Why This Might Be the Top of the The Market

Last week I wrote about many reasons why our local real estate prices may continue to climb. This week, I’ll give equal thought to the reasons why we may indeed be at the peak of what has been an extraordinary seller’s market.

Median Home Prices that Far Exceed Affordability of Median Incomes

Many cities on the Peninsula have seen real estate prices almost double over the last few years. Our local economy is strong, but are earnings rising enough to support this spectacular increase in prices?

Lenders have traditionally had a standard that a home price should be no more than 2.5 times annual income.

In Silicon Valley, the median home price recently exceeded $1 million. By traditional standards, a buyer would need an annual income of at least $400k to buy a median-priced home here. Although median incomes here are among the highest in the nation at $94,572.00 this is only a quarter of what would typically be required to buy a home. Combining two incomes is still less than half of that requirement.

In Menlo Park, where median home sales price is now over $2.125 million, the median income required by these standards would need to be over $800,000!

Another typical requirement is that a mortgage payment should not exceed 28 percent of a buyer’s gross monthly income. Using this calculation, assuming a 20% down payment, the buyer of a median-priced home in Menlo Park would need to make almost $400k per year. The number is lower than the other standard because of our current extremely low interest rates.

On the face of it, these numbers don’t compute. Skewing this ratio is the large amount of cash being put down (or paid in full) on homes, both by foreign investors and “regular people,” with stock options and parental help. A large down payment, combined with low interest rates, makes the monthly mortgage payments more in line with incomes. Additionally, a lot of buyers are stretching their budgets to buy as much house as they can possibly afford, optimistically believing that home prices and incomes will only go up.

We might do well to remember our last slump, and that things can change quickly that can have a big negative impact on housing prices. A few things that could change:

Rising Interest Rates

Low interest rates make mortgages more affordable, leading to higher housing prices. But if interest rates increase, the housing market could be in real trouble.

“Because wage appreciation has failed to keep pace with home value appreciation, once rates rise and the illusion of affordability driven by smaller monthly payments disappears, the market will be left with homes that could potentially be too expensive to afford on the typical median wage,” according to this Forbes article.

Foreign Investors Pulling Back from the Market

We have already noticed a bit of slowing among foreign buyers this spring. Trouble in the international economies, especially Asia, could lead to not only a decline in our real estate market, but huge global economic problems. According to this Bloomberg View article, a crash in the Chinese economy could have a global domino effect that might make our great recession of 2008 “look like a garden party.” As I write this, the Chinese stock market is down 19% from its June 12 hight.

And, as this article explains, toughening laws about foreign investment in our country could dramatically impact the housing market in “trophy” locales such as Silicon Valley.

Companies Leaving the Bay Area for Less Expensive Locales

Although Google, Apple and Facebook are expanding their footprints in Silicon Valley, other high-tech companies are finding that the cost of living here makes it difficult to recruit and retain employees. This is especially true for new start-ups that may be the next big wave of high-tech. Our median home price of over $1 million is approximately double what it is in other tech cities, like Boston or Seattle, and triple what it is in aspiring technology hubs, like Portland, Denver or Austin.

And then, there is worsening drought in California and other unpredictable events that could cause a downturn in the economy that could negatively affect housing prices.

We can mull over the data and ponder the possibilities, but the bottom line the same as always: Nobody will know where the top of the market is until it’s over.

For sellers, it is undoubtedly a fantastic time, with high prices, low inventory and pent-up demand. For buyers, if you can afford a home now, interest rates are still very low, making your mortgage payments more affordable than they will be if rates increase. If you plan to stay in the home for five to ten years, history indicates that your prices will hold or increase over the long run.

 

 

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