Housing Affordability: The Coal in This Year’s Stocking

Back in March we wrote about the rapidly decreasing affordability of housing in America. At that time we could not have imagined how much further affordability could decline in just nine months. Even with the sustaining strength of the job market, the rising cost of shelter continues to far outpace wage growth. Realtor.com recently predicted that home mortgage rates would average 7.4% in 2023. While that forecast is higher than most the trend is clear: Despite the current slowdown in housing prices and rental rates, affordability will remain a critical societal issue next year and beyond. As we approach the year-end holidays, it seems the best present Santa could bring is more housing units across the country to alleviate the continuing imbalance of supply and demand.

At the beginning of this year, 30-year fixed home mortgage rates were about 3.2% compared to the current 6.3%, after peaking at 7.1% early in November.^[1] That extraordinary rise in rates, even with the recent decline, means that a house selling for $500,000 (according to the Federal Reserve the average median home price in July was about $455,000) with a 20% down payment will require a $2,484 monthly payment, up almost $750 dollars each month from the beginning of this year. That’s an annual increase in housing costs of $9,000! Looking at it through an income lens, if the median household income is about $80,000, the portion of salary required for mortgage payments has risen from 26% to 37% in 2022, significantly above the benchmark 28% ratio.

The result of this meteoric rise in housing costs is a rapid drop in home sales and a leveling off in price increases. Redfin estimates that home purchases fell 30% in the third quarter, the largest drop since the Great Recession. American families are staying in their homes. According to Redfin, 85% of homeowners have mortgages with rates below 6%, so moving has become increasingly difficult, particularly for families wanting to move up from their starter homes. This creates a lack of mobility for families seeking new employment opportunities, a troubling situation when there is a such a large gap between job openings and people with the right skills to fill them.

Here are a few additional statistics that demonstrate the depth of the affordability crisis:

• Despite the economic turmoil and rising mortgage rates, the Case Shiller index of home prices rose from 282 in January 2022 to 300 in September, more than a 6% increase; the index has risen 42% since January 2020 (the index has started to level off in the fourth quarter but prices remain at record levels).
• Similarly, based on Federal Reserve data, the median sales price of a home has risen 38% since the first quarter of 2020.
• As a result of rising prices and rising mortgage rates, the National Association of Realtors (NAR) Housing Affordability Index fell almost 30% from 137.3 in January 2022 to 96.6 in September, and the index has fallen 43% since 2020; the NAR notes that the average price of starter homes rose from $255,200 in 2020 to $338,700 in the third quarter of 2022, and the first-time homebuyer affordability index dropped from 169.9 to 99.9 during that same period.
• The NAHB – Wells Fargo Housing Opportunity Index was 42% in the third quarter of 2022, meaning that only 42% of new and existing homes sold were affordable to households with a median income of $90,000 (in this analysis affordable is defined as housing costs being 25% or less of income); the index has fallen 36% since the first quarter of 2020 when 66% of homes were affordable.
• The lack of affordability is obviously weighing on the overall housing market; the NAHB – Wells Faro Housing Market Index, which reflects a survey of homebuilders, fell to 33 in November from 83 at the beginning of the year.

In March we wrote that the NAHB’s Priced-Out Estimate indicated that 70% of American households had been priced out of buying a home. The study was based on a 10% deposit and a 30-year fixed rate mortgage at 3.5%. The study indicated that each 0.25% rise in mortgage rates eliminated an additional 1.1 million households. Since then there have been twelve 0.25% increments in mortgage rates, resulting in an alarming 13.2 additional households priced out of the market in 2022. A Freddie Mac study confirmed that about 15 million mortgage-ready home buyers have been priced out of the market.

Distressingly, higher rates and lower demand for housing is deterring home builders from building more homes and increasing the supply, which would temper prices and somewhat alleviate the affordability burden. According to Federal Reserve data, the annualized rate of single-family housing starts in October had fallen to 855,000 units from 1,157,000 units in January. If there is some good news here, it is that multifamily housing starts have risen to 556,000 in October from 499,000 in January. Clearly, the lack of home ownership affordability is sustaining demand for multifamily rentals, including single-family rentals (SFRs). Yet the cost of rentals also continues to increase.

During the pandemic, apartment and SFR rent grew at historic rates and they have continued to rise, albeit at a much slower pace, in 2022. According to Yardi Matrix, in the first half of 2022 rents grew 15% and more recently have slowed to historic norms. As a result, average monthly rent is around $1,700, a 21% increase from pre-pandemic rates. Some markets have seen rent growth over 30%. Yardi Matrix reports that in October, the rent-to-income ratio reached 28%, below home ownership but still stressing the financial wherewithal of a large portion of American households. In fact, a recent study by MyEListing.com found that more than 50% of Americans spend greater than 30% of their income on rent. With respect to supply of rental units, Yardi Matrix reports that, despite the current pace of construction, the rental market is short 600,000 units.

The rising cost has slowed the creation of new households, which will ultimately drag down economic growth. We have entered a new interest rate regime, emerging out of the artificially low rates of the last twelve years of Federal Reserve accommodation. Higher rates are here to stay. So the one path left to cool rising prices is significant new supply. Of course, this is not an easy solution. As mentioned, developers are reluctant to build homes in this environment, rightfully concerned that they will be stuck with excess inventory if we have a recession. Moreover, inflation and supply chain disruptions have had a major impact on the cost of building materials, and land prices have soared.

The solution appears to be government support of housing developers at the federal, state, and local levels. Moody’s Analytics has reported that voters approved 70% of measures to support the fight against housing insecurity in the November election, and this majority was irrespective of political affiliation. Affordable housing bonds are a start, but governments must do more. Many jurisdictions around the nation are attempting to support renters through rent controls, legally limiting rent increases. While the intent of these actions is clear, they are often short-term solutions creating a greater long-term problem. Real estate capital tends to flow away from cities and states promulgating rent control, resulting in a slowdown of new supply that is the key to lower rents. The good news is that there are a growing number of federal and state legislative initiatives to stimulate the supply of housing, but new supply will take years to complete.

The affordability crisis will impact society and the economy for the long-term. The Pew Research Center earlier this year found that 85% of respondents in their survey were concerned about the availability of affordable housing. Higher home prices and rental rates are taking a financial toll on many and the Millennial generation in particular as a larger portion of income is allocated toward shelter at the expense of more general consumption. While the multifamily sector benefits from those priced out of home ownership, those renting families are losing the opportunity to have equity in real estate that supports long-term wealth creation. These trends are concerning and need far more attention from governmental leaders who can induce new supply into the housing market.

[1] Mortgage rates based on data from Freddie Mac