April 30, 1989
"A Method to Realty Madness - Crazy Housing Market is Cost of Economic Success"
San Jose Mercury News
By Timothy Taylor
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HOUSING prices have long been a sore spot around Silicon Valley, but lately they're feeling more like an open wound. The average price of a house in the San Jose area increased 17 percent in the first three months of 1989, according to the figures from the San Jose Real Estate Board. The average is now $230,000. And rising.

There isn't any rational economic explanation for housing prices that rise 17 percent in three months. But from the longer perspective of a decade or so, there are logical reasons why the price of the median home has tripled from its level of $73,400 in 1977.

The first factor is the national rate of inflation in all products. The lower line on the accompanying graph shows the increase in local home prices over time, while the higher line shows the prices in 1988 dollars, thus adjusting for inflation.

As the graph shows, local housing prices have moved in a jerky fashion, sometimes sharply up, once sharply down. The price of a home in Santa Clara County has increased 3.7 percent per year faster than the national rate of inflation since 1977. However, practically all of that increase happened in 1986 and 1988.

This 3.7 percent annual increase -- or the price surge of 1986 and 1988 -- can be traced to the powerful local economy here in Silicon Valley. Consider:

• Santa Clara County has added about 250,000 jobs since 1977. Meanwhile, the county population has increased by 230,000. Jobs have increased faster than population!
  
• New housing has struggled to keep up with job growth. The number of housing units in Santa Clara County increased from 459,000 in 1978 to 525,000 last year, according to the Federal Home Loan Bank of San Francisco. If those additional 66,000 housing units were filled with the county average of 2.83 people per household, they would have provided room for only 186,700 more people.
  
• Santa Clara County has the third-highest median income of any U.S. metropolitan area, with median income 60 percent above the U.S. average, according to Sales & Marketing Management magazine. In the average U.S. metropolitan area, only 18 percent of households have after-tax income above $50,000. Around here, the figure is 40 percent. Back in 1977, median income in this area was only 33 percent above the U.S. average.

When the jobs and income are here, but the houses aren't, the wealthier buyers will bid up the price of housing. As a rough rule of thumb, an extra $100 a month in mortgage payments will let you increase your mortgage by $10,000. If the higher incomes in this county allow some buyers to qualify for an extra $400 a month in mortgage payments, those buyers will be able to pay $40,000 more for a house.

The lure of reducing commute time will also inflate housing prices. Consider Silicon Valley workers who are deciding between a more expensive house in Santa Clara County with a shorter commute, or a less expensive house in Contra Costa County with a longer commute. For the sake of argument, imagine that the longer commute is 50 extra miles each day, and it will take an hour to drive. Say it costs 30 cents a mile to drive (counting gas, depreciation and insurance), and drivers value commuting time at $10 an hour.

At those (quite conservative) estimates, rational workers who have the money will be willing to pay $6,500 a year to reduce the commute. Using the rule of thumb given above, an extra $6,500 in mortgage payments will pay for an extra $54,000 of house.

If the price of every house in Santa Clara County had steadily increased 3.7 percent faster than inflation since 1977, the local housing market would seem a lot saner. After all, local economic factors will tend to have a larger effect on housing prices than on prices of other goods. With most products, if one business raises the price for its cars or clothes or haircuts, another business can come in and undersell it. But the supply of new homes is limited both by available space and the willingness of local government to approve new construction.

However, housing prices increase in spurts, and the spurts jump from one neighborhood to another. Spurts rarely make sense on their own; they need a context.

The national recession in the early 1980s pulled down local housing prices from 1981 to 1983, and then the recession in the electronics industry kept local home prices low through 1985. But in an area with enormous economic growth, the economic pressure on housing prices had to break through sooner or later. The surge in prices finally hit in the last few years.

This price surge may jump ahead too fast, so that local housing prices stay flat or fall a bit at some point in the next couple of years. But housing prices are not likely to rise so fast that they are set up for a stock-market-style crash. A stock market crash, after all, is created by too many people trying buy while the price is rising, but planning to sell at the first tick of trouble. When trouble hits and everyone tries to sell stock at once, the market crashes. But most people who are standing in line to buy a house around here are planning to live in the house, and they're not planning to pack their belongings and sell out at a moment's notice. The only reason for everyone to sell their home at once is if the local economy collapses, but that just means that the same economic factors which have pushed local home prices up could also bring them down.

Unhappily, the high price of a Silicon Valley home does make sense; it's a cost of economic success.

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