Thursday, January 24, 2008

A Little More Randal O'Toole Math

At the risk of beating the subject of Randal O'Toole to death, I want to clarify something I wrote in an earlier post. O'Toole wrote, "The national real estate firm Coldwell Banker reports that, in 2007, a Houston family could buy a four-bedroom, two-and-one-half bath, 2,200-square foot home for $170,000. The same house would cost more than twice that much in Portland." I responded by noting that the median family income in Portland is $57,952 and the median family income in Houston is $42,925.

Now one might look at those figures and think, if the houses are more than twice as expensive in Portland than in Houston, but salaries are only 35% greater then Randal O'Toole must really onto something. The thing to remember is that the house prices are not fixed in time because, unless you are rich, you generally pay these prices over many, many years.

So let's do a thought experiment. Let's say there are two twins, Larry and Jerry Median. Jerry gets a job in Houston at the median salary and buys a $170,000 house, as described above. Larry gets a job in Portland at the median salary and buys a $400,000 house (significantly higher than twice the Houston cost). Larry and Jerry each get 30 year mortgages at a fixed rate of 6.5%. They each get one raise a year of 2.78%, which is the average inflation rate from 2000 to 2007.

So who comes out better, the guy who got the inexpensive house or the guy who got the expensive house? Well, if we look at at what they both earned over the next 30 years as they were paying off their houses, we find that Jerry in Houston had $1,588,664 left over after paying his mortgage and Larry in Portland had $1,756,882 left over. So despite the fact that Larry paid well over twice as much for his house than Jerry, he ends up $168,218 wealthier than his twin in Houston.

This is why a comparison of house prices alone is fundamentally dishonest.

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