First stage: Pinpointing high house prices We’re looking for a way to spot areas where house price increases appear to be feeding on themselves for no apparent economic reason — in other words, the beginning of a bubble. To thin the herd of over 350 metropolitan statistical areas (MSAs) nationwide, we look at price-to-income (PTI) ratios. These ratios vary a lot across the country, so assessments have to be made relative to what is typical for each MSA. For example, San Francisco is a desirable location, and residents historically have been willing to devote a larger-than- average share of their budgets in order to live there. In addition, buildable land in San Francisco is extremely limited, so the supply of housing can’t expand to meet the high demand. As a result, the PTI ratio in San Francisco usually is much higher than it is elsewhere.
for sale. Nine of the 10 metros on our watch list have less than six months of inventory today. Three metros have between three and four months of inventory; four have between two and three months; and Portland has just over one month of inventory. Only Miami appears to have a balance between supply and demand. The increase in recent years in income inequality provides another reason increasing PTI ratios may not be signaling increasing house price risk. PTI ratios compare the median price of recently-sold homes to the median household income, including households that intend to remain renters and homeowners with no plans to move. The upward trend of traditional PTI ratios may indicate simply that more-affluent households are purchasing higher-end houses. Affordability may be decreasing for average- and lower-income households, but the households that are purchasing homes may not be stretching financially to do so. A review of loan-level Freddie Mac data provides mixed evidence on this hypothesis. The average of loan-level PTI ratios — the ratios of the house price to the income of the buyer of that specific house — is lower and less volatile than the traditional PTI measure. And, in fact, nine of the 10 metros on the initial watch list no longer exceed their recalculated thresholds. Only Miami still exceeds the outlier threshold.
our watch list. The ratios in these 10 metros are high relative to the historical experience in each metro. Interestingly, they appear in clusters — Raleigh and Charlotte in North Carolina; Jacksonville, Orlando, and Miami in Florida; Dallas, Austin, and San Antonio in Texas; and Portland and San Jose on the West Coast. Second stage: Are house prices headed for a fall in these areas? The PTI ratio doesn’t, by itself, identify potential house price bubbles. Other supporting information is needed. In particular, we examine the answers to three questions: 1. Are there nonfinancial reasons for the high PTI ratios? 2. Are credit conditions deteriorating? 3. Is leverage increasing? Are there nonfinancial reasons for the high PTI ratios? A key characteristic of housing markets currently is the limited supply of houses