Forget Affordability, Consider Capita per Inventory

by Scott Sambucci

What if everything you thought about housing affordability was wrong?

Traditional housing affordability indices by the National Association of Realtors (NAR), the US Census, and the National Association of Home Builders (NAHB) calculate “affordability” as a measure of home prices relative to median income. For example, NAR’s calculations are “Based on a 25% qualifying ratio for monthly housing expense to gross monthly income with a 20% down payment.” Of the 225 metros ranked by NAHB, Carson City ranks 6th nationally. Phoenix is 51st and Las Vegas is 59th, while Washington DC is 176th, the San Francisco-Bay Area is 224th, and New York is 225th.  

And all of these measures are flat wrong. 

“Capita per Inventory” – a calculation of how many people (capita) there are for each available home for sale (inventory) – is a truer supply and demand measure, determining the amount of demand relative to available housing supply. 

Here in the San Francisco bay area, we here it all the time: “How can anyone afford a house in Palo Alto with a median price easily over $1,500,000?”  Except that it is not anyone who has to be able to afford a house in Palo Alto, but fewer than 60 households because that’s how many homes are for sale right now in Palo Alto.   As long there are enough people with incomes able to support a million dollar home in Palo Alto, it very quickly becomes “affordable.”  With Apple, Facebook, Zynga, and the rest of the booming Silicon Valley tech companies, there are plenty of available buyers out there at these prices.

Examining five Bay Area cities for the week ending 11/11/11, the “Capita per Inventory” numbers are startling, and explain everything about home prices in these markets.

11/11/2011

Median
Price

Capita per
Inventory

Palo Alto

$1,745,395

1,512

Davis

$468,100

653

San Jose

$497,369

460

Stockton

$132,282

290

Sacramento

$143,894

274

 

Moreover, the home price data set since January 2007 reveals an 87% correlation on “Capita per Inventory” to home prices — as “Capita per Inventory” changes, so do home prices. The fewer the number of people per available home for sale, the lower the local market’s price becomes.

Stockton and Sacramento, where available housing inventory is relatively high, require significant in-migration or local demand (thousands of people) to clear the local market’s inventory, while more desirous towns like Palo Alto and Davis need about a hundred people to snap up the available inventory. Think Stockton and Sacramento measure poorly? Capita per Inventory in Carson City is 205, while Las Vegas measures at 106.

This concept applies more broadly to metros and regions.  The Bay Area, Washington DC, and New York, while they have their own local market variances, are considered more expensive and thus “unaffordable” by traditional methods. However, their Capita per Inventory measures relatively high compared to lower-priced markets like Phoenix and Las Vegas, considered by traditional measures to be “more affordable.”

Finally, Capita per Inventory has implications for municipalities and city planning policies. Zoning restrictions, school districts, and tax laws, if implemented effectively, can directly support home prices by restricting housing supply and increasing the demand to live in their towns.

Inflation-adjusted median incomes are flat to down since the recession, and the pundits talk in circular arguments — housing won’t recover until we solve unemployment, but we can’t solve unemployment until we solve housing.  That’s true in a national sense, but for the savvy investor crunching the right numbers, there are plenty of opportunities to find local markets where demand will always be relatively strong.

So when you’re at dinner and you hear – “Palo Alto is so expensive, but it’s a great time to buy in Sacramento – houses are cheap! I should buy two or three and rent them out!,” take five minutes and explain Capita per Inventory. Their nest egg will thank you for it.

(Note: Altos Research is a market analytics firm and does not provide investment advisory services. This article should not be construed as specific investment advice to buy or sell properties.  Consult your local real estate professional before making any real estate investment decisions.)

Scott Sambucci is the Chief Operating Officer with Altos Research – working daily with capital markets and fixed income clients to develop predictive models and applications using real-time housing market analytics and leading indicators.  He’s written numerous white papers on the topics of residential housing valuation and market trends. He also serves as an adjunct professor in the areas of Finance, Economics, and International Business.