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Housing affordability falls but still beats long averages
admin | September 28, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Current levels of home affordability still look strong, especially in a historical context. The gap between current prices and the higher price that households could afford to pay has tightened significantly as we move away from historically low rates, deeply distressed home values and a wide gap between home price and income growth. And the gap looks to stabilize absent a significant rise in interest rates.
Even though home prices continue to rise faster than wages, the median household still can afford to pay 20% more than the price for the median existing home sold. That is down from the 70% premium that the average household could afford in the early years of this decade but still well above levels before the 2008 financial crisis. Households look likely to hold onto that buying power in the next few years.
Exhibit 1: Premium that the median household could pay above the price for the median home sold
Source: NAR, US Census, Amherst Insight Labs, Amherst Pierpont. Note: Median home price reflects median existing home sale price as reported by the National Association of Realtors.
Affordability has fallen over recent years as US interest rates have come off historic lows and home prices that cratered upwards of 40% in some areas during the depths of the financial crisis. Home prices have outstripped income growth in recent years, further cramping affordability.
But affordability still looks reasonably strong through a longer historic lens. Current levels of household income, existing home sales prices and current mortgage rates suggest that median existing home sale prices are 20% below the level the average household could afford to pay. Our estimate assumes that a household would be willing to spend 25% of their gross income on housing and that they would finance 80% of the value of the home. An increase in DTI would improve affordability while increased leverage would push it lower.
The median household could afford to pay only 7.1% above the median sales price between 2000 and 2003 in somewhat of a normalized credit, albeit declining rate environment, significantly below current levels. Not surprisingly, the price premium was the lowest when credit eased the most during the crisis and the premium expanded massively as rates and home prices fell in the wake of the crisis.
Exhibit 2: Median home sales price versus price the average household could afford
Source: NAR, US Census, Amherst Insight Labs, Amherst Pierpont. Note: Median home price reflects median US existing home sale price as reported by the National Association of Realtors.
Households look likely to hold onto their buying power. The Amherst Insight Labs Home Price Index forecasts annual national home price growth between 1.6% and 3.1% over the next three years while Amherst Pierpont Chief Economist Stephen Stanley’s forecast for real median income growth over the next three years is between 1.6% and 1.8%. Given the flatness of the yield curve, forward mortgage rates in the Amherst base case Pay Model Fair Value scenario are roughly in line with current rates over the same horizon. The combined effect of the convergence of the levels of home prices and income growth coupled with relatively stagnant mortgage rates suggest that there should be little change to affordability over the next few years. Based on these forecasts, quarterly measures of affordability should fall between 17.6% and 21.4% over the next three years.
Of course, a sharp rise in rates could cut affordability quickly. Every 100 bp rise in mortgage rates would cut the price premium that the median household could afford by roughly 10 percentage points. If mortgage rates rose above 6.5%, current levels of affordability would be completely erased, likely providing a significant headwind to home price growth.
Exhibit 3: Impact of changes in interest rates on affordability
*National Association of Realtors US existing home sales median price NSA as of 8/31/18. ** Estimate based on 2017 median household income and assuming y/y growth rate of 1.8%. Source: NAR, US Census, Amherst Pierpont. Note: Assumes 25% front end DTI on 80% LTV loan.
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