Jul132009

## 1997: the last market bottom

What were the market conditions in 1997 at the last market bottom?

- The market peaked in the spring of 1990 at $245,000. In early 1997, the median was $223,750. It dropped for 7 consecutive years (The data series is a bit noisy, but the lowest low was recorded at $192,750 in May of 1994).
- There where bear rallies almost every year similar to what we are seeing now.
- The median household income was $62,022.
- The median home price was $223,750.
- Mortgage interest rates were at 7.6%. Rates had been steadily falling since 1982.

If a borrower puts 20% down on a $223,750 home, they are putting $44,750 down and borrowing $179,000. The payment on $179,000 at 7.6% interest is $1,263.87. This amount represents 24.4% of the median household’s $62,022 income.

**Think about that: in 1997, a family making the median household income could buy a median home with a payment that was less than 25% of their income.**

One of the erroneous contentions real estate bulls have made over and over again is that the median household income could never buy a median home. That is simply nonsense.

Twenty percent down was the norm in 1997, but what about the first-time buyers who were only putting 3% down with an FHA loan? They would have put down $6,712, borrowed $217,037, and they would have had a payment of $1,532. This payment would have been 29.6% of their income. By any standard, houses were affordable in 1997.

So what would these same market conditions which prevailed in 1997 look like today?

- The median household income in 2008 was $91,101. I doubt it went up since then.
- The current mortgage interest rate is about 5.25% (It fluctuates wildly lately).

If a family making the median household income were to put 24.4% of a $91,101 income toward a payment, they could make a payment of $1,852.39. That payment would finance $335,452. A 20% downpayment of $83,864 combined with the $335,452 loan would yeild a median home price of $419,316.

**If the people in 2009 were putting the same percentage of their income toward housing as those who bought in 1997, the median home price in Irvine would be $419,316.**

House prices did not go up by magic. People were utilizing crazy loan products that allowed them to borrow unbelievable sums, *and *they stretched beyond the limit to borrow these massive sums. The collapse of these loan products has already resulted in a huge decline in borrowing. People are still stretching to an insane degree and putting very large downpayments to keep our median at $550,000. As those with large downpayments spend themselves, and as people stop stretching to buy depreciating assets, the median will continue to fall.

Keep in mind that the $420,000 median we should be seeing is only supported by artificially low interest rates. If interest rates go back up to their historically stable levels of near 8%, the amounts financed drop even further.

What would happen if incomes were to remain flat and interest rates were to rise to 8% by the summer of 2011? (This probably will not happen, but it could.) **Using all the same parameters and an 8% interest rate yields a median home price of $315,561**.

- If you knew the median household income went up about 50% from 1997 to 2008 ($62,000 to $91,000), wouldn’t you suspect house prices would also have gone up 50% ($223,750 to $335,625)?
- Is it logical to think house prices can go up more than incomes?
- How are people capable of bidding up house prices higher than their incomes would allow?
- If lending standards retreat to 1997 standards (which they have), shouldn’t the relationship between income and price also mirror 1997 characteristics?

When I was interviewed recently at the Irvine Homes Blog (Blogger: Irvine housing market nowhere near bottom), I said that I believed the Irvine median would bottom near $375,000, particularly if interest rates rose to 7%-8%. When you look at the math, and look at the history, the crazy number that I threw out looks reasonable and even conservative.