As we talk to clients, we are hearing a similar question time and time again: When Will Prices Go Down?

Measures of housing affordability in Santa Cruz suggest that rising income levels in neighboring communities are pushing up housing prices. Santa Cruz residents are finding it challenging to afford homes and younger generations are leaving in search for lower-priced housing. To maintain a healthy, diverse, and vibrant community it’s vital that local economic growth keeps up with the rise in housing prices.

Take a look at the 10+ year trend in Santa Cruz and in the US from 1996 to 2017:

 

(source)

 

 

National median home prices rose by close to $120,000 or 85% from 1996 up to the recession. Median housing prices in Santa Cruz County shot up over $500,000, or 250% before falling. Was there more speculation in our local market? Possibly, though a growing economy in the Silicon Valley, willingness of affluent buyers to pay a premium for the Santa Cruz lifestyle, and perpetual low inventory of homes for sale may also explain the increase in prices.

 

In this post, Economists at Freddie Mac analyze “hot-spots” across the country using the Price-To-Income (PTI) ratio. When the PTI ratio rises above “normal” levels this suggests that housing is taking up an unsustainably large proportion of household budgets. It may also signal that home buyers are expecting housing prices to increase at a rapid pace.

 

When analyzing areas around the country with higher than normal PTI ratios, economist at Fannie Mae try to cite economic reasons for such growth. If they cannot do so, this suggests a bubble may ensue. For example, San Jose is one such hotspot with a high PTI ratio. Economist are not worried because San Jose contains much of the Silicon Valley and the tech-sector is typically more volatile. Housing prices will typically rise higher than the national average when tech is booming.

 

What about Santa Cruz? Here is a chart of the Santa Cruz PTI over the past 20+ years:

Click here for an interactive version of this chart (use the drop down menu to select Santa Cruz).

 

The only county in California with a higher PTI ratio than Santa Cruz is San Francisco. The PTI ratio in San Francisco are much higher than the national average because of its desirable location and low availability of space for new construction. Similarly, Santa Cruz is one of the most beautiful places on earth and people are willing to pay a premium to live here. Additionally, in this article, CEO of the Santa Cruz Chamber of Commerce Bill Tysseling, points out it is challenging to develop new property in Santa Cruz, thus perpetuating low inventory of homes for sale.

 

With that said, how high of a premium is sustainable for locals? The affordability index in Santa Cruz was 17 in Q1 of 2017, meaning only 17% of households could afford to buy a home at the current median home price. This suggests that the continued increase in housing prices may be explained by an influx of new, higher income residents from the Silicon Valley and other areas. As this chart shows, on average, workers in Silicon Valley were making 17.2% more money than their Santa Cruz peers in 2013.

 

(source)

 

If housing prices rise due to local rather than neighboring economic growth, we will be better off as a community. This would protect our market from the volatility of the tech-sector that fuels the growth in Silicon Valley and give young and middle to low-income residents an opportunity to buy.

 

Tysseling calls for reallocation of public funding. Investing in neighborhoods, transportation and schools; growing jobs; and housing development will fuel economic development. Doing our part to support these initiatives will enable more local residents to enter the market.

 

In conclusion, it’s true that prices are higher than they have ever been. We appear to be experiencing a shift in income levels in the surrounding regions rather than a housing bubble. If housing inventory increases or income levels fall in the San Jose area, we may see a gradual decline in housing prices unless income levels rise locally.

 

*The price-to-income (PTI) ratio is found by dividing the median price of recently sold homes by median household income.

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