Mortgage approval is the key to real estate prices
Real estate values for one to four unit residences are a function of the ability to get a loan, which in turn is a function primarily of mortgage underwriting. (Low and declining rates help somewhat to facilitate the ability to buy a property but do not help enough).
Many investment experts are quoted in the news as saying that the ratio of house prices to income is the lowest since either 1975 or even 1965. However this assumes that personal income is:
- Evenly distributed between all consumers (your pay is, on average, the same as Warren Buffet’s).
- Is all a guaranteed, stable, salaried “base pay” instead of irregular overtime pay, or income from self-employment.
- Based on the assumption is that the crash of 2009 somehow did not affect the two year average of income used to underwrite loans for self-employed people.
Examine the details to find the secret
The qualitative nature of nation’s personal income has changed a lot since the 1970’s. Back then there were a lot fewer self-employed and commissioned people. A lesser amount of the work force were employed as temporary workers in previous decades.
During the last several decades the qualitative nature changed in manner that is analogous to a stock market breadth indicator. During a market top a few prestigious companies continue to make new highs pushing the broad marker average slightly higher while the vast majority of stocks languish and fail to make new highs. The job market in the past decade consisted of the top 10% of the population getting good pay raises while the bottom 90% had stagnant wage growth. People may now hold two jobs or may have their income from a series of temp jobs with big employment gaps, or they may be an independent contractor or a small business owner. This type of income is riskier than an old-fashioned salaried job with a few years of seniority. This change was the price to pay to make America’s labor force globally competitive. But adjusted for the quality of income (a risk adjusted measure of income) the nation’s personal income has declined. Mortgage lenders evaluate loans according to this. It is more important than credit rating or having a large down payment, although that does not excuse bad credit or lack of a reasonable down payment.
Another analogy would be that today’s irregular workers (temp’s, independent contractors, etc.) are like Small Cap companies and their former salaried job was like a Large Cap company. During recessions Small Cap companies may be hurt by competition from Large Cap companies; it is during boom times that Small Caps get their best income because the Large Caps can’t fulfill orders fast enough. Until another boom comes along then the independent contractors will have aharder time buying a home.
Diagnosis foiled by smokescreen
This income problem was camouflaged by the use of “Easy Qualifier” no income documentation loans which were offered from 1984 until 2009. It was also camouflaged by the stock speculation of the 1990’s and the real estate speculation of the 1997-2008 bubble. Since Easy Qualifiers are now illegal and people’s incomes are much shakier than that of a generation ago that means that one can’t compare simple metrics of income to house prices over the past several decades. I wrote "80% of loans were not safe" and "Housing not comparable to the past" about this matter.
; The best comparison would be that of the post Great Depression mentality of consumers who for 20 or 30 years after the Depression would resist taking on excessive debt. It took 28 years for stocks to return to their 1929 highs in “real” terms. By analogy real estate should take that long also.
This misunderstanding by Wall Street about real estate finance reminds me of Bernanke, when asked during the real estate bubble about high house prices, responded by saying that high prices were symptom of a prosperous society that could afford to pay more for houses. Instead he should have seen through the smokescreen and realized that people were actually speculating in real estate in an attempt to earn more income because some of them may not have had enough income and not because they could afford more real estate.