Homes No Longer Affordable To the Average American

This post is a response to Jim Wiandt's recent post, "Without a Widespread Economic Crash, a Housing Crash Is Unlikely."

Hear no evil, speak no evil, see no evil. Does the National Association of Realtors have you on their payroll, Jim?

Your bluster and bravado on housing–and your steadfast reliance on worn-out folk wisdom rather than cold hard data–would make Baghdad Bob blush.

I'm not even sure where to start taking apart your argument; it has more holes than the Buffalo Bills' defense.

I’ll start with this chart from our good friend Bob Shiller.

click to enlarge

The chart shows the real value of homes, adjusted for inflation, stretching back to 1890.

Umm … do I have to say anything else?

(The chart is from a book titled Irrational Exuberance. You should read it. I’ll pick up a copy for you the next time I’m at Barnes & Noble.)

Affordable? You Must Be Kidding.

Let’s tackle the issue from your favored point of view: house price affordability.

You wrote: “The value of housing is roughly what the purchaser population can afford per month (a figure that will move up and down to some degree with interest rates of course) multiplied across the economy, PLUS whatever speculative and second-house market there is.”

For starters, it’s important to understand that recent housing trends have been driven by speculation. Here’s what the data say:

According to the National Association of Realtors [NAR], 28 percent of all homes purchased in the U.S. in 2005 were “investments,” along with 22 percent in 2006. With prices soaring, I think you could fairly call these speculations. Regardless, however, these buyers have disappeared, and I think the impact of these buyers leaving the market will be significant.

Affordability Index

Let’s get down to brass tacks: Can mom-and-pop homebuyer actually afford a house at today’s prices?

Since 1971, the NAR has been publishing a “Home Price Affordability” Index, which measures the ability of a median-income family to purchase the median-priced home. The index is VERY optimistic, as it assumes a family can plop down a 20% down payment and get the best possible mortgage rate. We know that’s not always the case, but let’s run with it anyway.

According to a report from HUD, the index originally came to market with a reading of 150 in 1971. It fell as we approached the 1982 real estate bust, and then recovered, and has hovered in the 130-to-140 range since 1993.

But since 2005, it’s cratered. In July, the NAR affordability index hit 103.6 nationwide … one of its lowest readers ever. In the Northeast region, it hit 90.4 ... which means the median family cannot afford the median home, even under the most optimistic of circumstances. In the West, the index reads 69.2. 69.2! That’s not even close.

Houses aren’t affordable anymore, Jim. That’s what the data say. And that’s why I believe what the futures markets are telling us: that home prices will fall 10-25% in the coming years.

Written by Matthew Hougan

Comments

[Richie:]

RIGHT ON, BRO!!!

2007 Sep 26 11:24 AM

[tlc8386:]

Finally someone gets it right!!! One thing not to forget is the tax situation---out here in Southern CA we have taxes that are out of control---mello roos--very high association costs--and then the state tax--insurance is also expensive if you add in earthquake.
It's not unheard of paying upwards of 20k in these taxes on our typical house here in CA. And a 5k a month mortgage is the norm. No wonder no one can afford to live here and foreclosures are booming out here. Everyone is taking from the homeowner!!!

2007 Sep 28 11:41 AM

[Malkiel:]

Thanks, Matt, for bringing back that point about median prices versus median incomes that nobody in the financial news industry seems to want to talk about. It seems obvious to me that there's a simple mathematical relationship at work which must be reflected in the market because it's absolute: each level of income can only afford a certain level of monthly housing costs after other living expenses are subtracted. You can jigger the figures a little bit, by reducing other expenses (say, lower gas and food prices, or cheaper import cars) or you can expand the range of affordability with trick financing (ridiculously generous ARMs with resets) but in the end the range always has an upper limit. The gap between median wages and median home prices can be justified by low supply: but eventually you run out of buyers at the upper income level and prices simply become unsupportable.

A lot of interesting things might happen during the adjustment--maybe older homes will be allowed to decay into unusability and come off the market as new construction is discounted, the way urban tenements disappeared from housing stock in the '80's and '90's; or maybe new housing will be in short supply as builders fail. But whatever happens, prices must reduce in the near term once the fancy financing disappeared and that bubble popped.

2007 Sep 26 11:30 AM

[No Stable E...:]

REAL ESTATE SPECULATORS HAVE MADE HOUSING UNAFFORDABLE FOR YOUNGER GENERATION:
I have been in market to buy house since Mid 2006 in Maryland. The house prices in this area have doubled since 2001 but most of the salaries have only gone up 10-30%. The speculators have made housing unaffordable for the new generation or anyone who was not able to get on the bus prior to 2001-2002. Any federal government bailout (using tax money of renters to bail out the home owners who get mortgage interest tax deduction) will hurt the young generation significantly by keeping these inflated prices high and forcing them to stay as renters. The house prices need to come down to match the salaries of average worker in this area in a free-market manner without intervention from federal government.

2007 Sep 26 02:07 PM

[Carl leason:]

Many , many thanks,....Right on target. !

2007 Sep 26 06:34 PM

[daskol:]

Powerful graph. It shows something else in addition to the incredible run-up in real housing prices of the last few years. It shows that the last time there was a crash in housing prices towards the upper-end of the spectrum you predict was the Great Depression.

So, the argument that a housing decline of the historical significance that you predict, well, it might not appear without a widespread economic crash--is it really laughable based on this graph?

2007 Sep 26 11:26 PM

[daskol:]

Powerful graph. It shows something else in addition to the incredible run-up in real housing prices of the last few years. It shows that the last time there was a crash in housing prices towards the upper-end of the spectrum you predict was the Great Depression.

So, the argument that a housing decline of the historical significance that you predict, well, it might not appear without a widespread economic crash--is it really laughable based on this graph?

2007 Sep 26 11:26 PM

[Nose:]

There is one counter-argument about a crash - who is buying the other 74% of the houses that aren't speculation? The nouveau-riche from Asia are what has eaten up all the houses on the west coast. Half the people in my area are recent immigrants, like me, working for hi-tech startups who can't find enough good people to hire. Also, ex-pats are going back home to Beijing, Moscow, etc and driving the prices for good property there to parity with San Francisco, so the speculation there is igniting a worldwide spike.

If there is any government intervention, it should be taxing the sale of second homes with a luxury tax to indirectly force the selling prices down by making speculation less profitable.

2007 Sep 29 12:14 PM