The Housing Bubble

I bought my first house last November in the notoriously expensive Silicon Valley. It cost me a staggering $713,000—astronomical by most standards—for a humble 1,600 sq. ft. townhouse in downtown San Jose. Further up the peninsula is even worse, with equivalent homes selling for over $1,000,000 in Mountain View or Palo Alto.

But why did I pay such an inflated price for my own home? How did I convince myself that it was worth the money? Practically everyone I know laments how unsustainable these prices are. No doubt, the rise in housing costs here is inequitable. It's a terrible problem—but today I'd like to set aside the question of fairness and ask: are housing prices actually in a bubble?

Testing for a Bubble

In a normal housing market, the dominant factor in house prices is income. Most people need to qualify for a mortgage to buy a house and most banks don't provide loans to households without the means to pay them back (sub-prime lenders aside). To know if we're in a bubble, we have to determine if a typical home buyer in my neighborhood could reasonably afford to get a mortgage and buy my house.

If the answer is no, there's a bubble. Some other factor must be driving prices up, be it foreign investors, shadow inventory, or rich techies with more money than sense.

If the answer is yes, then prices might be justified and sustainable. It makes sense to buy a house if you expect others would buy it for the same price.

You already have a preview of the answer (I bought the house) but let's investigate!

Income in San Jose

The United States Census collects income data for most cities and zip codes. I was able to find median household income for San Jose in inflation-adjusted dollars from 2009 to present:

Histogram of Historical Incomes

Two things about this distribution strike me as interesting:

  • Income is bimodal. One peak lies at ~$62,500 and another at ~$125,000.
  • San Jose is getting richer. The fastest growing peak is $200,000+ and it largely comes at the expense of the shrinking $62,500 class.

Housing Demand

Some other interesting facts from the census are that 96% of housing units are occupied, dispelling some of the fear of foreign investment and speculation that plagues other large cities. We can also see the number of households growing steadily year-over-year, from just under 300k in 2009 to just over 306k in 2013.

This paints a picture of a city already at capacity. A growing population of households earning $125,000 or more is displacing a slow exodus of households earning in the lower range of $62,500. These newcomers and their buying power determine the sale price of the small number of new homes that come on market. So how much home can they afford and how does that match up with San Jose prices?

Home Prices and Affordability

Trulia provides historical pricing data so we can track the rise of home prices from 2009 to today:

Median Price of Homes in San Jose

In order to compare that directly to the income data from the census, I've adjusted for inflation. The census values are in 2009 dollars; so are the adjusted values in this chart.

The median home in San Jose today sells for approximately $650k in 2009 dollars. Can a household making $125k a year afford that? By typical mortgage guidelines, such a household can afford a house worth about $655k, putting house prices right in line with the income of real people living in San Jose.

So is there a bubble?

Not in San Jose. Not yet, anyway. These prices are going to continue to track income growth and inflation, as a healthy housing market should. I can't speak for the towns farther up the peninsula, but I imagine the story there is similar.

None of this erases the deeper problems these prices cause. The lower peak of our income distribution, the one that's slowly shrinking? Those are our teachers, firemen, laborers, artists and friends. They're not sticking around to find out where this market takes us.

What are we going to do without them? Those of us fortunate enough to afford life here should seriously ask ourselves what we can do to make life affordable for everyone. But those are topics for another day.