Home Prices, Housing Expenses, and Personal Income: Who Ate My Paycheck?

As will be discussed in the California Outlook, personal incomes in the state are still reeling from the lingering effects of the 2001 recession.  Although nominal per capita incomes in California have been rising in recent years, real per capita incomes have still not recovered to pre-recession levels: continued weakness in the Bay Area has more than offset the small gains in Southern California.  And while the cost of living has risen in just about every category, the biggest increases have come in housing expenses, as measured by the Shelter component of the CPI (which is discussed in more detail in the California section).

While the same broad theme of sluggish real income growth holds true in the Bay Area, the severity of the 2001 recession means that the specifics are a little different.  First, nominal income growth has been substantially slower.  From 2000 to 2005, nominal per capita incomes grew by 16% in the U.S. and by 14% in California.  In contrast, nominal per capita incomes rose by only 7.5% in the combined San Francisco and East Bay metro areas (i.e. the San Francisco Metropolitan Statistical Area), and actually fell by 5.7% in the San Jose metro area.  While the aftermath of the 2001 recession has kept income growth weak in the Bay Area, it has also kept inflation in check.  From 1999 through the first half of 2001, the internet rush pushed overall CPI inflation in the Bay Area well ahead of the L.A. region: the overall price level rose 9.4% in the Bay Area compared to 6.3% in L.A. and 6% in the U.S. as a whole.  Most of this increase came from housing expenses: the Shelter component of the Bay Area CPI rose by 15% over this period, compared to 6% in L.A.  Not surprisingly, the 2001 recession radically altered these trends.  From 2001 through the first half of 2006, the Bay Area’s CPI Shelter Index has been almost flat, rising only 8%, which pales in comparison to the 29% increase in L.A.’s Shelter Index over the same period.

Fig 12: Bay Area Real Per Capita Incomes

Fig 13: Bay Area Consumer Price Index

So far, we’ve focused on the Shelter CPI as the measure of housing expenses, which attempts to measure only the increase in the cost of housing services, leaving out the “investment component” of housing.  As such, it is the most conservative estimate of the impact of higher home prices on living standards.  From 2000 to 2005, the Owner’s Equivalent Rent portion of the Shelter CPI (roughly how much the Bureau of Labor Statistics thinks it would cost an owner to rent an equivalent home) rose by 14.6% in the Bay Area.  However, the Census’ American Community Survey estimates that total ownership costs for houses with a mortgage (i.e. mortgage payment, property tax, maintenance, etc.) in the Bay Area rose by 31.4% over the same period.  While the academic debate about which measure more accurately captures the effect of home prices on standards of living continues, even the most conservative measures suggest that higher home prices are taking a bigger bite out of Bay Area paychecks than ever before.

Thus, while Bay Area per capita incomes remain among the highest in California, this distinction comes more from past success than recent strength.  Real per capita income growth has been weak throughout California, for different reasons: Southern California has seen housing inflation eat away at nominal income gains, while the Bay Area has seen weaker nominal income growth but smaller increases in housing expenses.