Home Sale Prices - How Can They Be so High?
By Steve Gillman - 2008
We can see that the real estate bubble has burst, but how
did home sale prices get so high in the first place? My wife
and I were in San Francisco and the surrounding areas recently
(2008), and were amazed at the prices there. A home that sells
for $100,000 where we come from in Colorado can be as high as
$600,000 in San Francisco, Monterey, Santa Cruz or San Jose -
and I don't mean ocean-front homes.
Furthermore, this is after the real estate bubble burst -
or so we thought. According to a report we saw on the news one
evening, parts of the San Francisco Bay area have still seen
double digit increases in home prices over the last year.
Of course, other areas have been hard hit. In fact, some towns
in California have seen prices drop in half in a matter of two
years. But how did they get so high to begin with? How do whole
populations of people buy homes that average a half million dollars
or more? After all, some of those buyers must work at regular
jobs, making only $30,000 to $40,000 per year.
There are several factors that lead to the high prices, and
some of them are still in place. That could mean that prices
might not fall much further. Then again, it could mean that if
and when we see those factors change, further big declines will
happen. Let's take a look at this.
Low Interest Rates Equal High Home Sale Prices
Here is an interesting little experiment you can try for yourself.
Get out an amortization book or find one of those payment calculators
online. See what the payment would be for your home at 13.5%
interest. That is what people were paying in the early 80s, by
the way. A 30-year loan of $100,000 would cost you $1,146 per
month for principle and interest.
Now look at how much you can borrow at 5.5% interest. That's
as low as my old amortization book goes, and lower rates were
certainly possible a couple years ago (although they were often
teaser rates on adjustable rate mortgage loans). For the same
monthly payment, you could borrow $202,000. In other words, the
sales price could be twice as high, and yet you could pay less
each month, and for the same number of years. You can see why
low interest rates allow prices to rise.
Of course, there is more to it than that, since prices certainly
more than doubled in most areas over the last twenty years (some
doubled in two or three years a short while ago). So what else
lets them go higher?
As incomes rise, people are able to pay more for housing.
More people who rent might be interested in owning a house as
well, and so the demand goes up, driving prices higher. Of course
that doesn't quite explain the extremes. After all, even with
a decent income of $60,000 per year, how does one afford a $500,000
During the real estate bubble, people came to expect home
prices to rise faster than inflation. Because of this, they were
convinced that a home is a great investment, and were willing
to stretch their budget to buy one. Where devoting no more than
30% of your income to a house made sense before, now buyers were
willing to spend up to half of their paycheck on their home.
More than that, though, there was a frenzy to get in on the
home price appreciation we all saw. So although a couple might
not actually be able to afford a home, they could buy it with
easy credit terms, drain their savings to make the payments for
a couple years, and then before they ran out of money, they could
sell for a profit. This kind of speculation became especially
common in California. Of course, now that prices are falling,
there are record rates of foreclosure. The game is over.
Other Factors That Help Explain Home Sales Prices
Easier loans allow more people to buy, which certainly helped
increase demand, and therefore prices. After all, even those
with decent income used to have to save for a down payment. No-money-down
mortgage loans changed that. Also, interest only loans, which
included half the loans made in California at the height of the
bubble, kept monthly costs lower. That $1,146 mentioned earlier
pays for a $250,000 loan with interest only.
Now add the fact that both husband and wife work more often
than not now, and you can see that they can pay a lot for a house.
Finally, there is one more factor that we discovered while
in San Francisco. More than one person told us that people are
sharing houses more than ever. One man told us that when he lived
in San Jose, most of the homes in his suburban neighborhood had
four families living in them, with perhaps six or more incomes
helping to make the payments. This is a cultural thing (most
were Asian or Hispanic), since many people born here don't like
the idea of living with other families. But nonetheless, the
fact is, those who are willing to do so have found a way to afford
a $600,000 home, and this supports the high home prices in the
Of course, in the end a big part of the answer to how people
can afford high home sale prices is that they can't. That's why
we are currently seeing record after record being set for foreclosures.
If we see interest rates rise in addition, we will see further
declines in those prices.
If you found this useful or interesting, please share: