A simple exploration of unemployment, real estate, population & the recession

Let me preface this post with a disclaimer; I am not an economist, real estate expert or statistician. The credibility of my theories could be estimated as very close to zero. This post is really more of a series of hypothesis from which I will draw a conclusion. Enjoy!

Recently, I’ve been getting into discussions with my friends & family about the condition of the real estate market in the U.S. - a lot of people seem to be under the impression that the market is going to “pick back up” in the next year or so. This has made me think more deeply about the underlying relationships real estate has - on the surface we have the simple principles of supply & demand, which works out fine as an explanation to why prices have deflated, there is a surplus of homes.

So, there is a surplus of homes. Why? Are the prices higher than they should be? Are there are not enough “high earning” people to buy this overvalued real estate? More importantly, are there even enough people to buy them, period? How many surplus homes are there?

I suppose we should start with home prices - are they higher than they should be? Let’s take a look at a few charts for an idea.

The big picture:

A more detailed view:

Nominal home values seem to have peaked at around $250k for a residence in 2006. According to Freddie Mac - the average mortgage interest rate in 2006 hovered around 6.2% - so the average cost of a mortgage (if you are not taking into account PMI, Taxes & other insurance) was around $1500.

$1500 does not seem like a lot - so let’s see what problems we run into as we do the math, taxes and insurance on a $250k home should be an additional $350-400. We’re now at $1900. Let’s keep going, according to Census Bureau the average HOUSEHOLD income was $48,201 or about $4000 per month BEFORE tax. Considering tax (about 20%) for that bracket, we come to about $3200 total for an average of 2.5 people per household. Now lets factor in the average credit card debt of $8,329 or a minimum payment of $412 each month. OK so we’re at about $2300 for the month - we have about $900 left over to take care of car insurance, car payments, gas, food & other miscellaneous expenses for at least 2 people. I say were probably at or around $0 every month.

So,I believe it is safe to assume there was a bubble & it popped - to answer my original question, are prices higher than they should be? Yes, they were.

Prices have adjusted are currently at around $175k - current interest rates have also dropped to around 4.2% and average household income grew 1.3% to $50,233 per year. Using this information let’s calculate what is needed now in order to sustain a 2.5 person household - for simplicity let’s assume average household credit card has remained the same & taxes/insurance total $300 each month.

Mortgage payment: $855 per month.

Income after taxes: $3350 per month.

Disposable income after expenses: $1565 per month.

On average - it appears people now have $1565 available for miscellaneous expenses like car insurance, car payments, gas, food, electricity, cable, etc. This give’s promise to the real estate market as it appears people may be able to sustain themselves long term based on these numbers - BUT this assumes the ratio of 2.5 people per household.

So now - this leads me to skip over the “Are there are not enough ‘high earning’ people to buy this overvalued real estate?” and go straight to “Are there even enough people to buy them, period?”

First let’s take a look at the population growth since the 2000 Census [source]:

So - we’ve seen close to a 20 million person hike in population over the last 8-9 years. That’s a good sign - except the number of residences has increased exponentially in the last 8-9 years as well. Take a look:

So - what the surplus in homes means is that for 20 million new people 12 million new homes have been created - that is not including projects with are under construction or in planning phases. I have no solid data source for this - so let’s just assume it’s a conservative 1 million. That’s a total of 13 million new residences available. Based on those numbers the ratio of people to home now drops to about 1.5 - bringing down the nationwide average to about 2.4 people per household. This displaces about 10 million individuals over all. In order for us to maintain the same 2.5 people per household ratio 5 million homes must disappear or be appropriated by the 10 million individuals.

So what does that mean? It means we have to figure out where these 10 million individuals are going to go - into owning one the 5 million rogue homes? Let’s see if the math fits…

The median (not average) personal income for a full time employee is $39,336 per year BEFORE tax. After taxes we are looking at about $29,502 or about $2500 per month. $855 for a home + $300 for taxes & insurance + $160 credit card payment (on $3200 debt). That leaves about $1300 left over for a car payment, car insurance, gas, food, health insurance, etc.

So the math works - except we haven’t taken into account the unemployment rate - which I have a feeling will be the killer here. Here’s the chart for the last 19 years:

It look’s like we’ve kind of hovered around 5.5% and been fine. So this tells me that, basically we need to create an additional 9.5-11 million jobs that are sustainable while maintaining our current jobs if we want real estate to flatten out.

Now - I know I haven’t accounted for certain things - like the $1.2 trillion US Dollars being printed by the Federal Reserve that will lead to inflation, a likely plateau in population due to Baby Boomer deaths & the fact that the unemployment rate is only representative of people LOOKING for work but all of the data presented above leads me to believe that we are at least 3 - 5 years away from a real estate recovery.

I never want to seem or claim that I “know it all” - so if anyone is reading this. Please let me know if I made any mistakes in my math or if you have any questions on how I reached certain numbers.

Thanks for reading!