OC LEADER BOARD

In our last Leader Board article in December, we argued that the claims made in a McKinsey study of a purported housing shortage in California are much ado about nothing.  

The McKinsey study points to California’s relatively low housing to population ratio as evidence of a housing supply shortage, one that needs to be corrected by adding 3.5 million housing units in relatively short order.

As we showed in our December piece, the McKinsey study that served as the basis for Sacramento foisting new zoning regulations on local areas doesn’t hold up to careful scrutiny. If there were a housing shortage, as the McKinsey study claims, the population to housing ratio in California would be increasing over time. In fact, that ratio hasn’t changed over the last 10 years, nor has the rent-to-owner-occupied housing ratio changed.  

But if there is no compelling empirical evidence of a housing shortage in California, why are home prices in the state so much higher than the rest of the nation?  

Case in point: The median home price in California in 2021 was $791,000, more than double the U.S.’s $350,000. And as shown in Figure 1, four of the five counties with the highest median home prices in our sample are located in California.

Recent research we’ve conducted sheds light on that question. That research involves a regression analysis where we examined the impact of various socioeconomic variables on median home prices for the largest 81 counties in the nation.  

We found that the two demand-related factors most closely related to differences in housing prices were median household income and amenities.

Our regression tests also revealed that the McKinsey study’s highly touted supply-driven population to housing ratio had no significance in explaining California’s high housing prices.

Not only did we find that median household income and amenities are significant, but we also discovered that these two demand-related variables account for 80% of the variation in housing prices for the 81 counties. The particularly close positive relationship between median household income and median home prices is shown in the scatter diagram presented in Figure 2.

Specifically, for every $10,000 increase in median household income, we found that median home prices increase on average by $120,000.  

The amenities variable is a score with a scale that ranges between       -3 and +11. Produced by the U.S. Department of Agriculture, it measures the physical characteristics of a county area that enhance its desirability as a place to live.  

The standardized scores measure warm winter, winter sun, temperature summer, low summer humidity, topographic variation, and water area.

On the amenities side of the equation, every one-point increase in the amenities scale leads to an increase of $22,000 in the median home price. These causal relationships are summarized in Figure 3.

To see how powerful these relationships are in explaining home price differences, one can analyze, as an example, the wide difference between Orange County’s median home price of $926,000 (5th highest) and Detroit’s home price of $146,000 (2nd lowest).

As shown in Figure 3, Orange County’s median household income of $96,000 versus Detroit’s $51,000 explains $545,000 of the difference in home prices.  

In addition, Orange County’s relatively high amenity score of 8.74 versus Detroit’s relatively low score of -1.73 explains $227,000 in the difference in home prices. Both income and amenities taken together explain a predicted home price difference of $772,000 between Orange County and Detroit. Notice in Figure 4 that this is very close to the actual difference of $780,000.

The same analysis can be used to explain Orange County’s median home price of $926,000 against San Jose-Sunnyvale-Santa Clara’s significantly higher $1,480,000 (2nd highest) home price tag. That difference of $554,000 is almost fully explained by household income.  

Orange County’s median household income of $96,000, which seemed high when compared to Detroit’s, now seems paltry when compared to the San Jose region’s household income of $133,000. Yet, that difference explains why Orange County’s median home price is substantially lower than San Jose’s.

These findings point to the fatal flaw in Sacramento’s draconian zoning dictates on local jurisdictions. It’s not an inadequate supply of housing that explains California’s high housing prices but rather the strong demand for housing fueled by our state’s high income and desirability as a place to live.  

Paraphrasing from Shakespeare, the fault, dear reader, is not in our supply but in our demand.