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Surprising new data on America’s house-price-to-income ratio crisis

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Colorado has enjoyed one of the hottest real estate markets in the U.S. over the past half decade, and that boom has only intensified in 2021. In fact, home values have averaged a staggering 20% appreciation across the state over the past 12 months. To put that into perspective, home values have averaged 3.9% appreciation annually since 2000.  

Although these upward curves are exceptionally steep in Colorado, they’re not out of character with the rest of the country. Booming home values have been great for sellers (and their real estate agents). 

However, a new report by Real Estate Witch has uncovered a disturbing trend: Since the 1960s, wages have been more or less flat while home prices have more than doubled, outpacing household income since the 2008 financial crisis by three times. 

This trend is making things increasingly tough — and maybe impossible — for buyers. 

Home Values Are Only Half the Equation 

At risk of stating the obvious, it takes money to buy a home. And these days, Americans are making less and less of it in relation to home appreciation. 

Using publicly available U.S. Census data, Real Estate Witch found that average home values since 1965 have more than doubled, rising from $171,942 in 1965 (adjusted for inflation) to $374,900 today. That’s a 118% increase in 56 years. 

Over that same period, median household income has increased from $59,920 in 1965 (adjusted for inflation) to $69,178 today. That comes out to an increase of only 15%. 

The bottom line? While home prices have more than doubled over the past half-century, wages have been more or less flat. 

This disparity has had a dramatic and sustained impact on the rate of homeownership. U.S. homeownership has fallen with each generation that followed the Baby Boomers. 

What Is the House-Price-to-Income Ratio Crisis? 

The homeownership rate has fallen, but people are still buying homes. A lot of people, in fact: 6.5 million homes were sold in 2020. So what exactly is the crisis, and how do we measure it? 

This is where house-price-to-income (PTI) ratio comes in. Economists use PTI to describe the relationship of a homeowner’s income to how much of that income they’ll be paying for their home. Think of it as the homeowner’s equivalent to the renter’s rule that you shouldn’t pay more than a third of your income toward rent. 

According to experts, a healthy PTI ratio is 2.6. That means the average home buyer needs 2.6 years to save up enough money for a down payment on a home and still have enough to allocate a reasonable percentage of their monthly income toward mortgage payments. 

In 2021, the average PTI ratio in the U.S. is 5.4. That’s more than double the recommended ratio. 

What this means is that, yes, people are still buying homes, but they’re taking a lot longer to save up for them, and then they’re taking on steep mortgage payments that eat up a portion of their income that’s more than twice what experts recommend. Today, the average U.S. home buyer is overextended, financially stressed, and has very little room for error.  

Experts also point out that high PTI ratios have a disproportionate impact on low-wage and manual laborers, essentially locking them out of homeownership. If we don’t reverse course, we could be looking at a future where even a modest starter home is a luxury good. 

Is It Getting Better or Worse? 

Essentially, we’re talking about two different curves here: household income and home values. Comparing them side by side, especially in more recent periods, gives us an idea of where the PTI ratio is headed. 

Home values and household income both dropped precipitously as a result of the 2008 financial crash. Since then, the real estate market has rebounded and then some, with home values going from a post-crisis low of $298,910 to $374,900 in 2021. That’s an increase of 25% in 13 years. 

In that same 13 years, median household income has failed to keep pace, increasing by only 8% — from $63,902 in 2008 to $69,178 in 2021. 

The result? Home prices have increased more than three times faster than household income since the 2008 financial crisis.  

Looking at an even shorter time span suggests the problem is still accelerating. In 2019, the PTI ratio was 4.7 — still far above the recommended level of 2.6. But in only two years, the average U.S. PTI ratio skyrocketed 5.4. 

Although a lot of this change can be attributed to the effects of the COVID-19 pandemic, it still suggests that the gap between income and home values is widening — and could grow into a chasm that could swallow the entire housing market. 

Selling in a Hot Market 

Of course, it’s not all doom and gloom. Conditions like these are a seller’s dream come true. But just because you’re entering a historic seller’s market doesn’t mean you shouldn’t do everything you can to maximize your sale. 

Don’t overlook basics like staging and cleaning. While buyers have a lot of tolerance for small (and even large) flaws in a home, you want as much competition as possible to drive up your final sale price. An imperfect presentation will drive off some buyers.  

Knowing that demand is so high, it may be tempting to set a high price. However, it’s often more effective to set your list price slightly low. This attracts more buyers, which increases your chances of competition driving high bids. 

Also, timing is everything. Consider listing your home on a Friday, as most buyers are out on weekends. If you get to the top of enough people’s open house lists, you could have an offer in hand — far above ask — by the end of the weekend. 

But don’t get too excited: once your sale is over and you’re all moved out, you’re going right back into the market as a buyer. And as we’ve shown, that’s getting harder by the day. 

Does marijuana legalization affect Colorado’s home values?

In 2012, Colorado became the first state to legalize recreational marijuana use with a vote of 55% in support. Since the first dispensaries opened in 2014, Americans have watched the state closely to see the long-term effects of the legislation. 

As other states and the District of Columbia have followed suit, one of the most notable impacts of the legislation has been an increase in property values. 

In fact, between April 2017 and April 2021, Colorado home values increased by an average of $89,377. Of course, not all of that is due to marijuana legalization, but a 2021 study found that, between April 2017 and April 2021, home property values increased by $17,113 more in states where recreational marijuana is legal, compared to states where marijuana is illegal or limited to medicinal use. 

Whether you are a private homeowner or a real estate investor, seeing a significant increase in property value will help your bottom line when it comes time to sell.  

Let’s take a look at some of the factors that contributed to that significant change in value. 

Dispensaries Correlate With Increase in Home Value 

According to the study, the number of dispensaries in a city has a direct correlation to property values. As the first to legalize recreational marijuana, Colorado is home to the most dispensaries in the U.S. As of July 2021, the state had 742 total dispensaries.  

For every dispensary added to a city, property values increase by about $519, according to the same study. In cities with recreational dispensaries, home values increased $22,090 more than in cities where recreational marijunana is legal but dispensaries are unavailable. 

 In comparison, for other homeowners around the country to add a similar increase in value to their home, they would need to make significant and expensive updates. The most profitable projects include installing new siding, making the home more energy-efficient, and renovating the kitchen and bathrooms with high-end finishes.  

These home improvement projects cost a lot up front and may put the homeowner in greater debt by having to take out a loan to cover the expenses. Even then, the return on investment may not always be as high when the time comes to sell.  

Increase in Tax Revenue Leads to Greater Home Value 

When promoting legalized recreational marijuana to voters, proponents of the law said it would increase tax revenue for the state. So far, that promise seems to be checking out. 

The real estate study found that home values increase an average of $470 for every $1 million dollar increase in tax revenue. In 2020 alone, Colorado collected $387,480 in taxes from marijuana sales. 

The revenue from this sales tax goes to support services that are attractive to prospective buyers — in Colorado, it goes toward supporting education.   

A portion of the money has also gone to build community buildings, such as health care clinics and schools. Between 2015 and 2020, the state gave $200 million toward school construction.  

One of the cardinal rules of real estate is location, location, location. When asked, most prospective homeowners say they are most interested in living in close proximity to good, well-funded schools, as well as public safety support, such as hospitals and fire stations.  

Reports also show that buyers are more likely to purchase property in an area with new developments in progress, including construction for major roads and event arenas. 

With Colorado investing its revenue well, the state is quickly becoming increasingly appealing to transplants from other parts of the country. This, in turn, creates a hot real estate market for sellers, who can make an even bigger profit on their home sale beyond its value. 

High Demand, High Profit 

While the real estate market has been hot across the United States throughout most of 2021, home values have been on the rise in Colorado for years. The reason: Demand for homes is greater than the supply. 

When new industries open in a state and more companies securing business loans to operate, it attracts new residents who need homes. This puts established Colorado homeowners in a prime position to cash in on their real estate investment.  

For example, with market values at an all-time high, a Colorado homeowner could make a substantial cash profit off of their home sale. Most homeowners expect to sell below market value during a cash sale, but with home values higher than ever, a homeowner could still walk away with a large return on their initial investment. Take a look at what is involved with selling a home fast for cash.  

With profit margins on the rise, savvy real estate investors can make the most of their profits through a 1031 exchange. In a 1031 exchange, a homeowner can defer paying taxes on the profits of their real estate business by investing them in a like-kind property within six months. Find out if a 1031-exchange could benefit you right now.