Opinion: Respecting the Median Multiple housing measure

By Hugh Pavletich*

There is a world of difference between being schooled in a subject and actually educated in it. As Mark Twain is reported to have said “I have never let my schooling interfere with my education”.

Over the past thirty years or more, thanks to the politicisation of urban issues and the housing market and increased affluence allowing the growth of social science education, “schooled experts” on housing and urban issues have become more prominent in the public arena and the main stream media.

Today we are deluged with policy and academic papers micro analyzing and commenting on housing markets and public policy relating to it, in language that is divorced from reality, as urban development and investment practitioners understand it.

The authors of these too often mind-numbing, tedious and long winded tracts, do not know what is
(a) important
(b) interesting and
(c) irrelevant.

Most of the taxpayer financed material fits neatly in to category (c).

Developers actually build cities – urban experts don’t.

There are the “doers” in this world and the “dreamers”.

Recently, a retired senior academic of a New Zealand  “social science” tertiary institution wrote to me, expressing his concerns about the standard of education in the urban planning area in particular –

“Our universities are churning out social scientists not as informed citizens who might then look for a career, but as people who have the expectation that they can turn their degree in to a career. Many of them head in to public sector employment and policy jobs, because there is nowhere else for them to go. And any time they are asked to look at an issue, they generate policy recommendations that lead to regulations. Because their knowledge is bestowed on them by weak (or doctrinaire) teachers, they do not have the critical capacity necessary for the job. Nevertheless, they can become part of the club which exerts considerable power, and persists (often becoming stronger) through changes in government. This applies to local and central government.”

“The result is not just over regulation, but poor regulation. Policy is based on imitation, workshops and group think.”

“While my leanings are (or were) more liberal than libertarian, this has led me to the position of seeing governments as inept and potentially a deadweight as a result of an entrenched and pedestrian bureaucracy that has circumscribed the discretion of the executive, ably supported by a lazy media that in turn limits the range of issues we might debate. There are exceptions to all of this I guess.

It’s past time social science academics started to realise that they have some major problems that need to be dealt with. Too many of their students are a menace to society. Rarely are they “wealth creators” (Bill Gates – a university drop out – he’s not the only one).

Market practicioners understand the limits of their knowledge

Experienced market practitioners, who’s judgment is constantly tested in the market place, are acutely aware of the limitations of their knowledge. In contrast - those who have simply been “schooled” in these issues,  with “no skin in the game” or practical experience, tend to articulate issues in more certain and complex terms, creating an “aura of knowledge” that seduces the unsuspecting within politics and the media.

... but economists (and other social scientists don't

As a further example - it is now well recognised the economics profession (the market experts supposedly) general performance in the lead up to the Global Financial Crisis was woeful. Indeed it was so bad they were “selling” property inflation as growth (as a doctor would suggest “cancer” is good for your health).

I covered this issue within an article early 2009 Housing Bubbles And Market Sense. Within this article, I quoted from a Portfolio.com article The End Of Wall Streets Boom,  by Michael Lewis (author of Liars Poker), in how a few within the finance sector ... a very few ... ”got it” about the dangers of the inflating housing bubbles and employed sound judgment to take advantage of the situation. Lewis wrote –

“At the end of 2004, Eisman, Moses and Daniel’s shared a sense that unhealthy things were going on in the housing market. Lots of firms were lending money to people who shouldn’t have been borrowing it. They thought that Alan Greenspan’s decision after the internet bust to lower interest rates to 1% was a travesty that would lead to some terrible day of reckoning. Neither of these insights was entirely original. Ivy Zelman, at the time the housing market analyst at Credit Suisse had seen the bubble forming very early on.

There is a simple measure of sanity in housing prices, the ratio of median house prices to income (my emphasis). Historically it runs about 3 to 1, by late 2004, it had risen nationally to 4 to 1.

‘All these people were saying it was nearly as high as some other countries’ Zelman says ‘But the problem wasn’t just that it was 4 to 1. In Los Angeles it was 10 to 1 and in Miami it was 8.5 to 1. And then you coupled that with the buyers. They weren’t real buyers. They were speculators’.

Zelman alienated clients with her pessimism, but she couldn’t pretend everything was good. ‘It wasn’t that hard in hindsight to see it’ she says “It was very hard to know when it would stop”. Zelman spoke occasionally with Eisman and always left these conversations feeling better about her views and worse about the world.

‘You needed the occasional assurance you weren’t nuts’ she says. She wasn’t nuts. The world was.”

Speculators super profits from political failure

Funds Manager John Paulson read the situation accurately, and as this Portfolio.com article from early 2009 explains John Paulson Profits In Downturn - Executives, made $US15 billion, by taking positions to capitalize on the downfall of the bubble markets and the poor quality lending associated with it.

Not surprisingly (at least to market practitioners) John Paulson changed tack during early 2010 as Professor Mark Perry explains within his Carpe Diem article  "Big Short" Paulson Continues to Be "Big Long" –

“John Paulson, head of hedge fund giant Paulson & Co, turned bullish on the US housing market in early 2010. Now he’s got a fund that’s betting on a rebound. One of the firms latest projects has taken it into the Sonaran Desert in the American Southwest in search of empty residential development lots. In November, the firm finished raising capital for the Paulson Real Estate Recovery Fund, gathering roughly $315 million in commitments from investors.”

“One of the funds main strategies is to buy undeveloped tracts of land that already have environmental and building permits. Roads, sewers and electricity may also be in place, but not homes, according to one of the people familiar with the fund. If the real estate market recovers enough for developers to start building more homes, this may be the type of land they buy first. That’s because a lot of the costly, time consuming preparation work has already been done, the person explained.”

Rather amusingly, Mr Paulson is taking advantage of political failures of the housing markets and in how politicians and planners disrupt the normal supply of new housing. No doubt he will be selecting his markets carefully, where the greatest “planning disruption” costs are - to maximize his profits going forward. Disruptive urban planners are a speculators best friend.

US National Assocation of Realtors respects median multiple measure

The United States National Association of Realtors within a recent release Global Survey: U.S. Homes Are Most Affordable has alerted its large membership within the affordable markets –

"United States real estate offers a lot of bang for your buck, according to a new survey that shows U.S. homes are the cheapest relative to incomes among English speaking nations."

"Australian homes – which have a median price of $454,000 – were found to be the most unaffordable among English speaking nations, according to the report by consulting firm Demographia, which examined affordability in the third quarter of 2010. The median home in Australia costs 6.1 times the gross annual median household income ..."

"On the other hand, U.S homes have a median home price of $168,000 and homes cost only three times yearly income or less." (my emphasis).

" ‘Australia has gone from being ‘the exemplar of modestly priced high quality middle-class housing, to now the most unaffordable housing market in the English speaking world,’ the report noted  ‘Each of the least affordable markets were characterized by more restrictive land use regulation, which materially increases the price of land and makes housing less affordable’ ".

"The United States boasted the most affordable markets. Atlanta was the most affordable big city, in which the median home price is $129,000."

"Meanwhile, the most unaffordable markets in the US were mostly found in California, San Francisco (homes cost 7.2 times income), San Jose (6.7 times), San Diego (6.2 times). New York (6.1 times) and Los Angeles (5.9 times)."

No mystery about affordable housing

There is nothing at all “mysterious” or “new” about the provision of new affordable housing – and importantly, the capacity of the construction industry to meet demand. Much of this issue is about relearning history (something academics would be well advised to do). The great construction industry entrepreneur William Levitt, ‘the father of suburbia”  following World War 11 (as this 1950 Time magazine article explains HOUSING: Up from the Potato Fields) provided new homes for $US8,000 to single earner families on $US3,800 per year – 2.1 times annual single earner household income.

Artificially induced housing bubbles and the housing affordability problems associated with them are simply an unnecessary nonsense.

The 2011 7th Annual Demographia International Housing Affordability Survey of the medan multiples of 325 major urban markets of the English speaking world, were –
Hong Kong (1 market) 11.4;
Australia (32) 6.1; 
New Zealand (8) 5.3;
United Kingdom (33) 5.2;
Ireland (5) 4.0;
Canada (35) 3.4 and the
United States (211) 3.0.

All the 115 affordable housing markets (at or below 3.0 times annual household incomes) were in Canada (9) and the United States (106) - as were nearly all the 94 moderately unaffordable markets (at or below 4.0 times annual household incomes) – with 74 in the United States, 17 in Canada and 3 in Ireland following its housing crash.

It is likely now the local business, real estate and residential builder associations of the affordable markets, with their members  within both Canada and the United States, will follow the lead of the US National Association of Realtors, in using the Demographia Surveys  to promote their markets. This is already happening on real estate agents blogs (here, here, here).

Normal affordable housing market defined

The Median Multiple measure is an essential foundation in understanding what a normal affordable housing market is. The following definition is on the writer/s website Performance Urban Planning –

“For metropolitan areas to rate as ‘affordable’ and ensure that housing bubbles are not triggered, housing prices should not exceed 3 times gross annual median household incomes. To allow this to occur, new starter housing of an acceptable quality to the purchasers, with associated commercial and industrial development, must be allowed to be provided on the urban fringes at 2.5 times the gross annual median household income of that urban market.”

“The fringe is the only supply or inflation vent for an urban market.”

“The critically important Development Ratios for this new fringe starter housing, should be 17 – 23% serviced lot / section cost – the balance the actual housing construction.”

“Ideally through a normal building cycle, the Median Multiple should move from a Floor Multiple of 2.3 through a Swing Multiple of 2.5 to a Ceiling Multiple of 2.7 – to ensure maximum stability and optimal medium and long term performance of the residential construction sector.”

Scarcity or perceived scarcity is the “trigger” of housing bubbles – finance is simply the “fuel”, as I explained within an article mid 2010 Americans Slow Learners About Housing Bubbles. Within this article I drew to readers attention, an important speech to the  U.S.Real Estate Editors Conference, given by Mike Insulmann, co-founder and President of the respected US construction industry research firm Metrostudy. Mr Insulmann was particularly concerned the “public conversation” of these issues has yet to take place in California and other US bubble markets. In contrast, this important conversation has been underway in New Zealand and Australia for a number of years.

New market stock and bubble stock

Generally, as the Annual Demographia International Housing Affordability Surveys clearly illustrate, most of Texas urban markets stayed within the mid to high 2.0 Median Multiples. Some such as Austin went a little higher, and no doubt the State of Texas authorities are examining why this has happened, requiring that local government to sort out its regulatory costs.

Texas has a sound mix of open market policies with appropriate infrastructure financing (bond financing Municipal Utility District model) and sensible Mortgage Consumer Protection laws as this article explains - The Lone Star Secret - CNBC.

The State of Georgia too has open land markets, but no Mortgage Consumer Protection Law, as Professor Paul Krugman explained within a New York Times article back in April 2010 - Georgia on my mind. Not surprisingly, the lax lending in Georgia led to over production of new housing stock – but not a bubble. Last years Demographia Survey illustrates how the Median Multiple for Atlanta fell to 2.1 – this year it has moved to 2.3 Median Multiple, as this over-production is being cleared.

Over production of “market stock” is far less of a problem than an artificial scarcity induced housing bubble and the “bubble stock” generated.

New “market stock” is housing construction of
(a) the type the market wants
(b) where it wants it and
(c) within sound Development Ratios.

In contrast – new “bubble stock” is
(a) where people don’t want it but the planners force it to be
(b) of the type real buyers – not speculators – don’t want and
(c) outside sound and normal Development Ratios.

Miami is an excellent example of the latter. Ireland too.

Focus on simple structural issues

It is clear those “schooled” in urban issues and housing must start thinking the way market participants do. Mirror the market – not be divorced from it.

Within an early 2008 paper Getting performance urban planning in place, the writer explained the major political drivers triggering unnecessary and destructive housing bubbles and the importance of getting sound and clearly understood performance measures inculcated in to local government culture.

Academics within the fields of economics, urban planning and property appraisal / valuation need to play their part in assisting in restoring housing affordability, by teaching and researching structural urban economics – from the foundation of the critically important Median Multiple measure. 

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* Hugh Pavletich FDIA
Co author – Annual Demographia International Housing Affordability Survey
Performance Urban Planning
Christchurch