Affordable Housing Institute : US

Feel like you’re paying more for housing than you did twenty years ago?  That your housing burden is rising?

 

 

If all you read were the endless ‘housing bubble’ stories (2,100,000 word finds on Google!), you would be convinced, as fairly clearly most Americans are convinced:

 

When the list prices of houses are climbing as they have in recent years, it can be hard to imagine that real estate is more affordable than it once was. In a nationwide New York Times/CBS News poll conducted this month, 75% of respondents said they thought most families in their community spent a larger share of their income on housing now than in the 1980’s. Only 5% said the share was smaller.

 

Well, as a fascinating — one might even say revelatory — New York Times article reveals, everything we thought we knew is wrong:

 

 

And indeed, it’s easy to find charts suggesting that prices are rising fast:

 

Source: New York Times, October 2, 2005

 

Economist, March 3, 2005

 

But, measured against historical standards:

 

PORTLAND, Me. - Despite a widespread sense that real estate has never been more expensive, families in the vast majority of the country can still buy a house for a smaller share of their income than they could have a generation ago.

 

From the New York Times, a spectacularly useful chart

 

How can we reconcile these apparent contradictions? 

 

Marjorie and Tim Gilbert bought a house in Maine for $176,000 this year by taking out two mortgages.

 

A home is bought not in cash (except for the very fortunate few) but with financing, so the purchase of a home is made not in one lump sum but rather in a long series of payments.  Hence the home’s affordability ties not to its price but rather monthly occupancy cost divided by income.

 

Nationwide, a family earning the median income - the exact middle of all incomes - would have to spend 22% of its pretax pay this year on mortgage payments to buy the median-priced house, according to an analysis by Moody’s Economy.com, a research company.

 

The share has increased since 1998, when it hit a low of 17% before house prices began rising sharply in many places. Although the overall level has reached its highest point since 1989, it remains well below the levels of the early 1980’s, when it topped 30%.

 

In rental housing, we use 30% of income as the Federal standard.  This norm — affordability means 30% of income for occupancy costs — applies with extraordinary linearity across a very wide band of incomes. 

 

“People aren’t really shopping prices,” said Bill Trask, a broker at Coldwell Banker Friends and Neighbors Realty in suburban Portland, ME. “They’re shopping payments.”

 

 

A monthly mortgage payment (MMP) is the product of a debt service constant (DSC) times a purchase price (PP).  But simple algebra reveals, of course, that:

 

House price affordability in algebra

 

If MMP = DSC * PP

 

then

 

PP = MMP / DSC

 

Said in English, if debt service costs go down, prices go up but affordability remains unchanged.  And debt service costs have gone down:

 

The sharp fall in mortgage rates - from above 10% through most of the 1980’s to less than 6% in the last few years - is the main reason.  Upfront mortgage fees have also dropped to about a third of a percentage point of a loan’s value, from 2.5% 20 years ago.

 

That eightfold drop in fees (from 250 basis points to 35) means more than just cost savings: it also encourages shopping, and because of that it creates stronger competitive pressure on capital providers.  As money becomes a commodity, both capital and intermediaries face downward yield pressure:

 

Computers have made lenders more efficient, and huge pools of global capital have brought more competition to a business that was once largely local.

 

In addition, better information has enabled lenders to offer higher loan-to-value (LTV) financing, which lowers the borrower’s Weighted Average Cost of Capital (WACC):

 

Beyond cost, many families who simply could not have bought a house 10 or 20 years ago find themselves able to do so, thanks to changes in the ways banks lend money. In the past, a home buyer often needed to make a down payment equal to 20% of a house’s value to get a mortgage; today, little or no down payment is common.  [And then there are the first-time homebuyer programs. — Ed.]

 

Of course, there was another obvious affordability indicator, if we but had the wit to interpret it:

 

The long-term decline in housing costs also helps explain why the homeownership rate remains near a record of almost 69%, up from 65% a decade ago.

 

In other words, if housing was so much more expensive, then why was the homeownership rate steadily climbing?

 

 

In fact, relative to income, house prices have seldom been more affordable:

 

In Dallas, the share of income needed to buy a typical house has fallen to 13% this year, from 14% in 1995 and 31% in 1980. In Tampa, it has dropped to 21%, from 26% in 1980.

 

Even in New England, where the soaring prices of the last decades have frustrated many young families, house values have still not reached the heights of the early 1980’s, when calculated as a share of income.

 

As markets vary dramatically, the Times thoughtfully included a nifty affordability calculator for your market.  But the general trend is clear:

 

“Over 20 years, affordability has definitely improved because interest rates are much lower,” said Kenneth T. Rosen, chairman of the Fisher Center for Real Estate and Urban Economic Research at the University of California, Berkeley. Houses have also grown bigger during that time, he said, so people are getting more for their money.

 

Bigger boxes on smaller lots is a prescription for more affordability.  A house is a technologically evolving object.

 

If most folks are getting a better bargain, why then is the news so relentlessly gloomy?

 

In high-profile places like New York and Los Angeles, home to many of the people who study and write about real estate, families buying their first home often must spend more than half of their income on mortgage payments, far more than they once did.  

 

“I’m sure my market is representative.”

 

Besides, imminent catastrophe sells more papers than sunny optimism.

 

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