John M. Lee: Is Real Estate Overpriced?

This past month, with the mortgage market in a state of disarray, the media reporting on lenders going out of business, the number of sales declining, and foreclosure rates going sky high, many potential buyers are asking, "Are our real estate prices too high?"

Let's examine this question and I will give you some food for thought. The long-standing belief, especially about San Francisco real estate, is that housing is overpriced and unaffordable relative to income. This was true 30 years ago and it is still true today. In fact, it's always been this way in this area.

The affordability index, defined as the percentage of households that are able to purchase the median priced home in the area with a 20 percent down payment, hovers between 8 and 15 percent in San Francisco.

Our statistics show that we are a city of approximately 70 percent renters and 30 percent homeowners, with many many of the homeowners having purchased their homes a long time ago. So how can we sustain the real estate market with such a small percentage of buyers? Because there is a problem using the "affordability index" as it pertains to San Francisco.

The measure of a healthy market is localized. If the affordability index in Oklahoma is at 15 percent, the market would die because the demand will be substantially lower than the supply.

However, in the Bay Area, 15 percent means that it's a seller's market because we do not have enough supply to satisfy the demand of people wanting to own property in the Bay Area. The index fails in that it incorporates only ordinary income into the equation. The key to developing a better formula is to include a much broader long-term measure of permanent income, which includes capital gains, physical assets and future earning potential.

The Baby Boomers are starting to reach retirement age. We have the largest segments of the U.S. marketplace owning the greatest amount of wealth we have ever had in this nation. This wealth shall be passed along to the next generation, which has fewer numbers of people. Thus, the wealth per capita will increase with the passing of the torch.

The purchasing power will be much higher for the next generation of buyers. They are not making any more land and it's especially true in a city like San Francisco. With a few exceptions, our land has all been built out and we are not making any more. Because land is a scarce commodity, it will hold its value and continue to appreciate.

Real estate prices behave differently because it's not a commodity good. It's immobile, and provides services, such as shelter and security, to its owners. Owners become emotionally attached to their homes. If prices were to fall, most owners have the ability to hold on until prices go up and enjoy their home in the meantime. When prices do drop, they have the ability to continue paying their mortgages, allowing them to hang on until prices get better.

About the only people selling are those under financial pressure. Once those properties are sold, prices will rise once again and go beyond what was paid for them.

For questions, call Lee at Pacific Union at (415) 447-6231.