November 01, 2006

Doing The Housing Bubble Math Dance for California.

How much more expensive is it living in California than say in 1970? We can speculate, guess, do the housing bubble cha-cha or we can use hard data and numbers to see the actual cost of living in California in 2006. This post was inspired by the lack of actual data contrasting inflation, rates, current prices, and rents and putting the numbers together in some tangible form. In addition, this data was inspired by a Northern California realtor who decided to actually crunch the numbers. So are you ready for the housing bubble math dance? Let us proceed:

1. First, we need to agree that rates are at all time lows. Our assumption is that these are artificially low in terms of historical data. According to Freddie Mac, since 1971 rates seem to average about 7.5% so we will use that as our mortgage rate. We will use this rate since one of the primary arguments is housing always goes up so we can also state that rates on average have hovered around 7.5%.

Assumption #1 - Mortgage Rate of 7.5%

Data Source:

2. Looking at Census data, we see that in 1970 rent was $484 a month in 2000 dollars. By using an inflation calculator to adjust we get a monthly rent figure of about $107. You can use the below inflation calculator to derive this number.

Assumption #2 - Rent in 1970 adjusted for inflation was $107

Data Source:

3. The C.A.R. (yes, not the most trustworthy source for data) put out a study regarding the median price of family homes. It shows the median California home in 1970 priced at $24,640.

Assumption #3 - 1970 Median California home is $24,640

Data Source:

4. You can then go to Bankrate and calculate that with 20% down, which again was typical at the time, would leave you with a loan of $20,000, and the mortgage payment would be approximately $140. With taxes and insurance, about $30 more, you would have a total of $170 PITI.

Assumption #4: $20,000 Mortgage with 20% down

Data Source:

Again, assuming tax breaks that housing offers, this would yield about a $30-50 monthly savings, meaning that it would cost $32 more per month to own.

After these numbers are calculated you can use Tom's inflation calculator again and find that the difference in today's dollars between renting and owning should be about $170.

Here is a rough breakdown of the above for those who visually do better:

Now tell me where in California will you find a place that has a rent/own difference of $170 per month?


bubble_watcher said...

This is an excellent post, Dr. Housing Bubble!

Now, the next thing to do is to make a price drop / rent increase estimate that would be required to bring this $991 dollar difference into the historical norm of $170.

To make things simple, though, you should assume no rent increases for the next few years since many flippers/home sellers are putting houses up for rent while most apartments have vacancies.

Add in a recession, and you could also have rents dropping at the same time real estate drops in price, as well.

As a sidenote, CalculatedRisk has a nice price to rent ratio chart for San Diego:


With rents unchanged, we are looking at a drop from 1.6 to 0.8 (recession), which would correspond to a 50% drop from peak prices..