Banking Strategist

HOUSING PRICE-TO-INCOME RATIO

The Housing Price-to-Income Ratio is an interesting and valuable measurement of housing valuation and affordability.

When purchasing an asset - whether it is a company through an acquisition or a home, there are two primary decisions to be made:

1. Investment Decision: What is the value of this asset that is being purchased? In an acquisition, this measurement can be made by using the “price-to-earnings”, or P/E ratio. This is how much is paid for each dollar of earnings generated by the asset. The higher the P/E ratio, the more expensive the asset. The value paid may be deemed reasonable if the asset’s value in the future is expected to rise more rapidly than assets with a lower P/E ratio.

2. Financing Decision: How will the purchase of this asset be financed? For an acquisition, it may be new equity through issuance of stock or it may involve debt. Measurements may include years to payback based upon cash flows or earnings contribution after financing costs.

For the “investment decision” for a home purchase, the P/E ratio depicts the number of years of family or household income that will be invested to purchase a home. A high Housing Price-to-Income Ratio will depict an expensive housing market.

For the “financing decision”, the prospective homeowner will measure the percentage of the financing costs to the family’s income.

Affordability Perspective: the more years of family or household income that one must invest to purchase a home indicates lesser affordability. In this case, the family or homeowner must divert more of their income to paying for the home rather than saving or investing in other financial assets (e.g., 401k, investment portfolio, etc.).

Housing Price to Income Ratios - Large Metropolitan Markets