# Home Run!

by on November 28, 2006

Loyal Cafe patron
Chris Demetra points out in an e-mail the following interesting facts about
housing in the USA.  (I’ve modified his data somewhat, using
new homes rather than existing homes; the data are more consistent that way):

1981:

Median New Home Price
- \$100,688

Median Square Footage – 1,550

Price / SqFt = \$65

Mortgage Rate = 16.6%

Monthly Mortgage
Payment on 1 SqFt = 57 cents

2005:

Median New Home Price
- \$240,900

Median Square Footage – 2,245

Price / SqFt = \$107

Mortgage Rate = 5.9%

Monthly Mortgage
Payment on 1 SqFt = 64 cents

Note that these are
nominal dollar amounts, and when I calculated the monthly mortgage payments I
assumed a 30-year fixed-rate mortgage.  (The 1981 median home price,
expressed in the data-source below in 2005 dollars, is above deflated, using
the CPI, back to the 1981 price.)

If we express in 2005
prices the price per square foot of a median American home back in 1981, we get
\$123.

That is, even
disregarding all the improvements that houses today have over houses in 1981,
the reduction in mortgage interest rates combines with the substantial increase
in the size of the typical home to permit Americans today to pay just barely
more than half of what they were paying a mere quarter-century ago for their
household living space.

Here are the data
sources:

UPDATE: I agree with the commentors who point out that 1981 is too-unusual a year to choose for such calculations as above; it was indeed a year with unusually high nominal rates of mortgage interest.  So the monthly-mortgage-payment/square-foot figure in 1981 compared to 2005 is not a good comparison.  I should not have offered this comparison.

Nevertheless, commentor Joe Blalock is mistaken when he writes:

Your result is entirely mortgage rate driven.

Other than the rate effect, the notion that the cost of the home per square foot is lower now is laughable.  Sorry

Forget about mortgage-interest rates.  Look only at the price of homes and the square footage of these homes: \$65 per square foot in 1981 (in 1981 dollars) and \$107 per square foot in 2005 (in 2005 dollars).  So if we convert the 1981 price into 2005 dollars, we find that the price per square foot of the newly built median-priced American house in 1981 was \$140.

That is, on a square-footage basis, the real price of the newly built median-priced home today is about 25 percent lower than in 1981.

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Bruce Hall November 28, 2006 at 5:43 pm

So much for the housing bubble….

Perhaps a similar comparison should be made for salary of the Chairman of the Federal Reserve who is so concerned about inflation.

Joe Blalock November 28, 2006 at 5:46 pm

You result is entirely mortgage rate driven.

Other than the rate effect, the notion that the cost of the home per square foot is lower now is laughable. Sorry

Michael Sullivan November 28, 2006 at 6:04 pm

The interest rates in 1981 were highly anomalous. You refer to a time when many people worried that our economy was in major collapse and headed for another great depression (or the inflationary equivalent).

I don't think anyone would doubt that things were pretty bad in 1981. It would be instructive to perform the comparisons for another time when interest rates were more reasonable, perhaps 1974.

Square footage is also problematic, since neither marginal value nor marginal price of extra square footage is linear, yet you have produced a price per square foot as if that is a reasonable proxy for housing cost. In order to find houses with 1550 square feet in 2005 if that be your preference, you must usually pay a much higher price per sf than for a 2250 sf house, or you must accept certain locational disadvantages that you would not have had to in 1981.

The most frustrating thing is that you probably have a point, but you've specifically chosen all your parameters in a way that biases the demonstration in your point's favor. It's much more convincing when you can do the opposite and *still* make your point.

Robert Coté November 28, 2006 at 6:21 pm

1981 interst rates? Why not 1934 employment rates?

python November 28, 2006 at 9:11 pm

Why shouldn't we use 1981? People all around this country are trying to convince us that the economy is awful, that the middle class is getting pinched, and that I will soon lose my job to an enslaved Indian or Chinese. It is extremely illuminating to compare supposed bad times to another time that was not that long ago. If you think we currently have a bad economy it's probably because you are comparing it to an unreasonable extreme (such as the bubble days in 1998-2000). I'm happy comparing now to any year, it would still win by almost any measure.

Secondly, any one with half a brain can figure out that the information presented was not only mortgage-rate driven. Why are homes getting larger if we can't afford them? Anyway, mortgage rates didn't drop below 10% until 1986. And it's not like mortgage rates are some random phenomena, there were reasons they were so high. So it's not just a housing story.

In addition, more Americans own their homes now then ever before. At 69%, up from 65% in 1985. Obviously something non-negative is happening in the housing market in the past 25 years.

Umayyad November 28, 2006 at 11:28 pm

Are you comparing apples to apples? The source data doesn't assure that median home price purchased the median home size.

Morgan November 28, 2006 at 11:33 pm

Almost a year ago (how time flies) I put together a related graph here:

http://photos1.blogger.com/blogger/467/1896/1600/Affordability%20and%20Interest%20Rates.gif

The chunk of per capita GDP (which I was using as a proxy for income) devoted to financing the median home has been steadily falling (with interest rates) since 1981. That ignores the square footage and quality issues.

The "bubble" seems to have impacted median home prices relatively little.

Joe Blalock November 29, 2006 at 9:08 am

When you buy a house you don't buy by the square foot.

Show us a constant quality index(if you know what that is) that also adjusts for the size of the house that shows houses are now cheaper than 1981 (why not 1986?) and I'll believe you. (Pythons's comment addresses this second point) For now, you just as wrong: you've only admitted you had even biased the results further by using the ridiculous interest rates you used.

Mike November 29, 2006 at 10:25 am

Well, all of this data is nice … but isn't it better to just look around you? I see bigger and nicer houses being built. I see tons of renovation. And I see nearly 70% of Americans still buying houses. I don't care what the numbers tell me when I can observe people's behavior. And that behavior suggests that people are choosing to spend their incomes on homes.

Michael Sullivan November 29, 2006 at 11:22 am

Morgan: I got a 403: Forbidden error when I tried to access your graph.

spencer November 29, 2006 at 11:45 am

Joe –The single best measure of a constant quality index for housing is the Office of Federal Housing Enterprise Oversight index of repeat purchase prices.

Repeat purchases only measures the price of a home when it is resold so it is always comparing the current value of a house against the value of that same house when it last changed hands. Consequently it is the single best measure of housing prices and what a home of the same quality cost now compared to some point in the past. It avoids the problem most other home price indices measures have of comparing apples to oranges.

that index has gone from 100 in the first quarter of 1980 to 398.85 in second quarter of 2006.

Interestingly, from 1995 to 2005 it showed that the rate of price increase in homes was about 7% compared to the BLS report that home owners equivelent rent rose at a 3% annual rate over this period.

The peak rate of year over year increase in home prices according to this data was 14% in 2005 II and it has slowed to a 10% rate in 2006 II. The peak quarterly increase at an annual rate was 19% in 2000 IV and it rose at a 4.8% rate last quarter.

Using annual data from 1981 to 2005 this measure of home prices rose from 100 to
340 while nominal median family income rose from 100 to 243 and nominal mean family income rose from 100 to 278. So depending on which measure you use average family income rose either 71% or 81% as much as the price of buying the same quality home.

spencer November 29, 2006 at 12:30 pm

One of the problems with using the new home price data provided by the Relators index is that there are massive cyclical swings in the average that make years like 1981
unrepresentative.

The data is a simple averge.

But what happens in a housing downturn is that builders drop out of the bottom-end of the housing market first. They quit building low price homes and only build high price homes on the premise that lower income people are squeezed out of the maket first.

But because the price data is a simple average it does not adjust for this change in quality so in a poor housing market like 1981 the average price of new homes experiences a large artificial surge that massively distorts comparisons to other years.

So when you are using this price series you should use at least a 5 year moving average.

Joe Blalock November 29, 2006 at 12:30 pm

Thanks Mike Sullivan

CASE CLOSED

POINT: Home prices have gone up faster than inflation and income in the past 25 years.

Yes, the demand is there but there is a demographic push (including illegals) and tremendous unreported income as well.

Michael Sullivan November 29, 2006 at 12:52 pm

Don: I like your updated analysis better, although I still think going per square foot is not totally accurate.

But just looking at a deflator, I see that 2005's median new home price in 1981 dollars is 107660, or just 7% higher than 1981's median new home price, despite having 25% more square footage. Even if you value marginal square feet over 1550 at \$0, you can probably find stuff in the market for 7% less that gives up 20% of the square footage but not much else. So housing is at most 7% more expensive in dollars than it was in 1981, and probably somewhat less expensive (depending on how you value marginal square footage, and the options in your particular market).

Given the huge reduction in interest rates, it would be crazy for house prices not to be more expensive. If Interest rates had gone from 16% to 8% between 1981 and 1982, what are the chances that real house prices would have risen only by 7%?

So it doesn't really surprise me to find out that housing is not more expensive than it was in the 80s. It's definitely more expensive than it was in the late 90s, though.

I just went back to look at the data and got more quibbles, though. I see that you used "new" home prices. But if you look at existing home prices (which make up *much* more of the market), things are not nearly so rosy. The 1981 median sales price of existing homes was only about \$62000 in 1981 dollars. The 2005 median of 219000 works out to about \$98000 in 1981 dollars. Which is a bigger increase than there was in square footage, so it makes your whole calculation look different. It looks like even the real cost per square foot thus rose about 9%, and the cost without looking at sf rose about 58%.

It looks like the premium cost of new housing relative to existing housing has come down a lot, but that's not that relevant for most people who are perfectly happy not paying any premium at all for new housing.

Why specifically did you look at new housing costs only? I guess it eliminates inconsitencies of how long houses have been around and what kind of shape they are in, but I would expect the whole market to be pretty similar. Maybe there's some slight improvement on that score, but I can't believe it accounts for the whole difference in the new/old price gap. I expect that people's desires for more square footage (it's much more efficient to build 2000 sf houses than 1200 sf houses and has been for some time), and improvements in construction productivity are responsible for most of that shrinkage, rather than improvement in the quality and upkeep of existing houses.

It does look like the square footage averages are only available for housing starts, so it's possible that "existing" square footage increased by even more, but that's hard to say with no data. It strains credulity to believe that it has increased by enough to make the calculation look similar to your original.

Sorry, Don, but the more I look at the data, the more the whole calculation looks fishy to me. It seems like cherry picking the data that makes your point best. Things are clearly not as bad as the economic naysayers try to make them sound, but looking at *all* of the data, house prices seem pretty high right now. Is it really important to deny that?

Mr. Econotarian November 29, 2006 at 1:05 pm

My new house is HUGE! Much, much larger compared to my parents' built in the 1960's, and just affordable to the two-working parents with graduate degrees. I am so much better off economically than my parents were at my age.

And it is the smallest one I could buy on the lot! Two families could live in my house comfortably.

Michael sullivan November 29, 2006 at 1:12 pm

Mr Econotarian: If you could have purchased a house in the same neighborhood that was half the size (as well as half the lot size) for half the money, would you have done so? I would guess the answer is "in a second". In fact, I'll bet given your description that if you could have purchased a house in the same neighborhood with half the lot size and half the house sf for even 75% of what you paid, you'd have at least seriously considered it over the house you bought.

If that's accurate, then the assumption that cost per square foot is what drives people's decisions is pretty silly.

Michael Sullivan November 29, 2006 at 1:35 pm

spencer:

I'm not sure I believe that the repeat purchase price index is actually going to do a better job of holding constant quality than other measures.

As houses get older, if they aren't renovated, their quality goes *down* as they get more likely to have various problems. OTOH, If they *renovated* their quality generally goes up significantly as people modernize fixtures, appliances and electrical work, and often add rooms or square footage in the process.

I don't see how you can assume these things cancel each other out exactly, and it looks very difficult to control for both. My quick look at a paper put out by the OFHEO looks like they make no attempt to control for either effect.

I would guess that the same location is closer to constant quality over time than a random sample of different locations, but I think it's highly optimistic to assume that this index really represents a constant quality price in the sense that we'd like it to. The author of the paper I read as much as said it's just the best you can do when you can get no hedonic information whatsoever with your price data, but you do get addresses.

Morgan November 29, 2006 at 1:51 pm

MIchael:

Strange, I get a forbidden error now, too. It worked last night.

Well, it's the second of the two graphs on this post:

http://yargb.blogspot.com/2005/12/housin-bubble-or-blowin-smoke.html

If that doesn't work, I'm out of ideas.

spencer November 29, 2006 at 4:04 pm

But it still does not invalidate the point that this is still a better price index then the other indices commonly used.

Adam Malone November 29, 2006 at 4:08 pm

Why has an increase in home ownership been so over looked in this discussion? Looking over the comments I see that it has actually been mentioned or referenced very little.

I am not going to debate the validity of the data, instead I will make this point:

Naysayers must been wrong in at least one way.

Naysayers say that homes are more expensive now than at some point in the past. Naysayers also say that wage growth has stagnated and wages are deflating even as we read this.

Income is without a doubt the most important factor in determining the selling price of home. IF wages were decreasing, it is logical to assume that demand for homes is decreasing as well, thereby the price for those homes would go down as well.

The second most important factor determining the price of home is supply. And I understand that if demand for homes is decreasing (which is the corralary to stagnant wage speak)it is likely that suppliers will limit the amount of new homes entering the market. Yet for two fundamental reasons we know this is not the case:

1)The US population is growing, and has been growing for QUITE some time.
2)Home ownership has increased.

Therefore: Despite the naysayers' mantra, they must wrong in at least one way. Either wages are growing, houses are getting cheaper, or both.

Does anyone have data on home ownership in Europe?

Michael Sullivan November 29, 2006 at 4:24 pm

Adam: rentals could be getting expensive faster than home ownership. That would cause ownership to increase even though it became more expensive relative to wages. Or things other than housing costs could have become much less expensive, giving people freedom to spend a greater % of the income on housing.

There's also the fact that mortgage rates do matter to what people can afford, and those are very low right now. If they stay low, the high house prices aren't a big deal. If interest rates jumped 3 or 4 points and house prices and wages stayed roughly the same, there would be a *major* housing crunch for anyone in the median income range or lower. Of course prices would almost certainly come down in that event (if wages did not go up), how much and how fast is hard to say.

I don't think you can make a really good case about the legitimacy of complaints vis-a-vis high home prices without figuring out how much to weight interest rates vs. raw prices, and it doesn't look completely clear to me what the "correct" way to do that is.

But prices are pretty clearly high relative to income by historical standards, despite the attempts to portray otherwise.

I agree with you that this does not represent a good argument that the sky is falling. If the sky were falling or anything close, we wouldn't see the increase in home ownership that we've seen.

Michael Sullivan November 29, 2006 at 4:27 pm

Spencer: You are correct that it's a better estimate than plain median home prices. I did not mean to imply otherwise.

It's certainly *far* better than using only new homes, which are a pretty small portion of the market, and one affected by many positive factors that do not affect the rest of the market.

spencer November 30, 2006 at 11:04 am

Michael — the important thing to remember about housing is that it is a very long lived asset and that the stock only grows by some 1% – 2% annually. The median age of the US housing stock is 30 years — ie, half of the housing stock was built before 1976. So when you look at new home sales you are looking at the marginal purchase that can be and often is very different from the average.

Thomas Zoellner May 12, 2008 at 2:50 pm

The monthly payments for 30 year or 15 year fixed mortgages are the main considerations for many people who are looking to buy a home. No-one wants a mortgage hanging around their neck forever but with home buyers entering the market later, an early repayment of this loan is important. However, before you rush in and sign any papers, there are points to contemplate. One point to remember is ensuring that your monthly mortgage repayment remains the same throughout the entire period of the loan.

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