I'll adopt the naive assumption that over the long haul, home prices and household incomes should move in tandem with one another. It's easy to come up with reasons why that assumption might fail, but it seems like a good starting point; in any event, it has worked pretty well in the past.
Consider the chart below, which shows home prices and household incomes for the three-county region that includes Marin, San Francisco, and San Mateo Counties.
The pink diamonds represent an index of median household income. The solid blue line is the OFHEO home price index. (OFHEO stands for Office of Federal Housing Enterprise Oversight.) It's not a perfect index (among other things, it includes only single family homes), but it correlates closely with other common home price indices, and it's a particularly convenient index for purposes of this analysis. Both series are indexed to a value of 1.0 in 1999.
As you can see, the two series tracked each other closely over the 25-year period ending in 2000. After that, prices climbed much quicker than incomes. By 2006, the ratio of home prices to household incomes exceeded its pre-1999 level by about 80%. The ratio has fallen dramatically since then, but is still about 45% higher than its long-term average.
Notice that I haven't talked about what the price-to-income ratio should actually be. Instead, I've pointed out that the ratio has been stable in the past, and that it's now far above its long-term average, even after the recent price declines. As I said, it's easy to come up with arguments as to why the "fair" level for the ratio should have risen. But I don't know if those arguments can stand up to 25 years of history.
Note: The household income figures were obtained from the Census Bureau. You can find the OFHEO home price index here.
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