Upside to Falling Prices: Housing Affordabilty Index Reaches 4-Year High

The chart above shows the National Association of Realtors' Housing Affordability Index [HAI] from 2005 to Feburary 2008 (annual averages for 2005 and 2006, monthly in 2007 and 2008), based on the national median-priced home, median family income, and the 30-year fixed mortgage rate.

The HAI has gone from 103.6 in July 2007 to 135.6 in February 2008. A composite HAI of 135.6 means that a family earning the median family income ($59,967) in February had 135.6% of the income necessary to qualify for a conventional loan (at 5.94%) covering 80% of a median-priced existing single-family home in February ($193,900). This increase of more than 31.6 points in the HAI in just seven months, from both falling home prices and falling mortgage rates, is already starting to have a positive effect on the housing market (February sales increased) and could continue to play an important role in the recovery process for the slumping real estate market.

Housing affordability is higher today than at any time since early 2004. For the perspective of homebuyers, aren't we now in a real estate boom, since affordability is the highest level in four years?

Comments

[Kostya Tszyu right hand]

Reasonably priced houses...
people living within their means...
people purchasing gas sippers...
oh the humanity.

[User 133274]

I am a Realtor and the NAR only submits information to achieve its goals.
The author of this article may have a Phd but obviously he has been in the classroom way too long.

Disagree that the affordability index has increased. I am on the front lines and see buyers denied daily. Too many buyers place more emphasis on the cars, and other toys they have to obtain and finance. Too much debt!

[Mark N]

I don't know where you get your numbers, but in real life families can
't afford to pay these prices. Read a paper. Does mortgage crisis sound familiar.

[ponchovilla]

Mark: Shame on you.
Let's see the detail on how NAR comes to the conclusion that $59,967 allows the purchase of a $193,900 home.
1. Where does the $38.7K cash down come from? Mom & Dad? A lottery ticket? Pawn shop loan?
2.What are the assumptions on closing costs?
3. What is the real finance rate?
4. What is the debt/income ratio?

Please provide these devilish details and allow us to laugh at the "real estate boom" we're in. Finally what % of mortgages today are approved with the top line assumption of $60K buys $194K.

[redriver]

What a tool!

It is and always has been: AAA Fico, 20% down and 2.5X your gross household income = max. mortgage

Don't have it..........go get it

Considering the fact that "affordability" went right out the window in 2000, "highest affordability since 2004" is so NAR: once again, building homes on foundations of mud.

[nickgogerty]

the NAR affordability metric is bogus as is most anything "economic" that comes out of the NAR. The NAR is a marketing association. I bet if Coke put out a drinkability index based "economics" people wouldn't question it either.

["Magazine-Cover-Indicator" Indicator....]

While lots of self-defeating rhetoric and cooked numbers from the NAR will probably help put more and more realtors out of a job (by prolonging the seller reluctance to adjust prices), it's still true that no matter what houses are a good buy only if the price of a house isn't much higher than about 150 times a monthly rent for a similar size. By this "floor", prices are high to very high in most cities.

[Malkiel]

I tend to believe the 20% down payment assumption is there because that was a standard assumption back when the index was started, but it really needs to be reconsidered--most housing in all income brackets for a couple of decades has been bought with much smaller down payments, such as the FHA 5% or 3% or 0% ARMS, because 20% has never been realistic for most buyers. You simply wouldn't have a housing industry if we stuck with the 20% standard, given the heavy inroads that other forms of credit have made on consumer habits for a couple of generations...

[User 169726]

Gotta love the NAR spin. When prices fall it's a great time to buy because houses are affordable. When prices rise it's a great time to buy because prices are rising and you better buy now before you are priced out. Head I win, tails you lose.

What else would you expect from an organization of used house salesmen?

[Bob Yarrow]

A much more realistic and meaningful picture would be painted with information that goes back to 2001. The real estate market has not been functionly normally since mid 2003.

[vreporter]

Dr Perry, if we are discussing the Michigan market - where you live - affordability is probably true. But with all the Michigan jobs going out, when does that data point filter into the result? Also, mortgages can't be gotten as they were for the past four years. So I'm afraid this index is as credible as the NAR itself. But I see that there is no need to convince any readers here of that. What used to be a widely followed economic release has now been exposed as nothing more than a selling tool. Mr Yun has no job left! It's time for another entity to take over this data compilation. Maybe your institution?

[ZMaNFaRLee]

I could agree that homes are getting more affordable. I live in Florida and just purchase a home (south florida, the worst area now). Families can afford homes in the area. I thought the reports showed incomes rising even while more jobs were being cut.

Point being is that the problem with a lot of purchasers is financing. Banks won't lend very easily, credit is unusually tight right now. Once these institutions can get the bad debt off there books (and the fed is in a way helping by making a price when it loans against the securities) they can start lending more loosely again. Not like in 05' but maybe like they did before then bad credit got no loans but decent credit did.

The underlying fact is the home I bought I paid about 10% then what it sold for in 2003 (5 years earlier). 2004 was when the run up got going and peak was in 2005. On just my example it seems to me that prices are falling to where they should be. And while a 10% decline could be in order due to the fact the market tends to overexert itself when moving a direction, to think price levels will fall below prices that were there before this whole thing started is going against the grain. And it was going against the norm that got us into this mess.

[PublicLiterature.org]

Finally an article showing that the housing market isn't trending like the Japanese asset bubble. If mortgage rates stay low, home prices are clearly more affordable. However, this is exactly how we got into this mess to begin with. As inventory is reduced, interest rates will be allowed to climb. Hopefully, this time around, speculators won't jump in and homebuilders will be reasonable with their new home development.

[rdial54]

Nice to see houses are more affordable now. Guess we have to rember that real estate is for the long term. Can't play games with loan applications and hope that you can pay later. Buy what you can afford and don't be too greedy a speculator. The government and lenders made things too easy. And many mortgage brokers took advantage of the system.

[Al DiAlberto]

The falling prices correspond to the prices comming back to reality. Just because people bought over priced homes doesn't mean that is what they were worth. We are seeing pricing that better reflects the actual value of home for sale. We are seeing real customers comming back to the market looking for value and sustainable homes.

[naples]

the only way to ensure you don't get hosed in RE is do buy such that the owner's equivalent rent per month (tax adjusted) is below market rent.

for weighted avg cost of capital (7% debt at 80% of purchase price vs 15% cost of equity at 20% of purchase price) -- or me i use 8% for debt got give me what i think is normalized interest rate. the WACC is 8.6%. so calculate the tax adjusted (you have to adjust also for the std exemptions on federal taxes) cost of capital, property tax, insurance, and maintenance per month. if this is lower than a conservative market rent for the house or condo then you are guaranteed to make money in RE over time.

this doesn't mean idiots wont bid the mkt up BUT i have seen time and time again, the mkt trade below mkt rent providing tremendous oppty for home buyers -- investors and homeowners. It WILL happen. RE is long cycle so anyone who thinks the mkt will rebound like a "V" is an idiot. also, we have seen this countless times. Home prices bottom after starts (4-5 yrs after top) and stays down for another 3-5 yrs before income and inflation pushes prices higher.

if you use the method i outlined above, you will be guarantee yourself a profit (assuming there isnt problems with house or changes in the neighborhood). the other methods of using affordability index or mkt comps exposes yourself to abnormal conditions.

i can tell you that pretty much the coastal regions have a ways to go down. West coast has so much pain left, its ridiculous -- as well as FL. I have heard even ridiculous defense on why someone should pay more to own than to rent, its all a lie to protect their own interests. I've been thru a few cycles and they are all similar. we have not even gotten to a tighten credit environment -- we just went from very loose credit to nornal credit (20% down good fico scores). when we get to tighten, banks wont lend for simple condos unless you put 30% down and require owner occupancy at 70-80%. when i bought investment condos in NYC when this happened (1992), i made a fortune. i bought outer borough condos for 25-30K and its now valued at 300-400K. i dont sell because they are now yielding over 30% pre tax. so BE PATIENT and you will be REWARDED!!!

[naples]

the only way to value RE appropriately is to measure the cost of ownership per month to a conservative market rent for the property.

calculate the cost of capital (use 7% rate for debt at 80% of home price and 15% equity cost at 20% of home price -- WACC is 8.6%), property tax, insurance, maintenance and tax adjust the costs (you have to not overadjust for taxes because everyone has std exemptions in federal tax codes). personally i use 8% of debt cost. compare this figure on a monthly basis to conservative mkt rent. if you buy a property where cost of ownership is below the mkt rent then you guarantee yourself a profit because inflation, real wage increases and population growth will push prices and mkt rents higher.

this doesnt mean the mkt is not going to pushes prices higher where cost of ownership is higher than mkt rents BUT if you dont follow this rule you are accepting lower returns and giving money alway as we have seen in recent years.

in every cycle (been thru a few), the prices always trade to a level such that investors (landlords) can profit handsomely and hold property for over a life time. currently, we have not even hit TIGHT credit yet. We just move to normal credit -- 20% down. TIGHT is when banks require 20-30% down and 70-80% owner occupancy rate for simple condos. the last time we had tight credit was early 1990s when i bought outer borough condos in NYC for 25-35K. they are now worth 350-450K. i wont sell because they are yielding over 30% pretax in net rent (after maintenance).

so be PATIENT. Dont use affordability index or mkt comps or past prices. Use the comparison between ownership equivalent rent vs mkt rent. if you use the rates i suggested above then you guarantee yourself 15% rate of return on your equity -- which is nice if you live in your own property. in addition, if you buy right using this method, then other home buyers (not investors) will see the economic incentive to buy your property if you have sell. NO ONE will tell you this because most people are home owners or have an incentive to tell you otherwise.

from what i can see the coast regions have a ways to go -- AND it will get there as i have seen in the past. RE are long cycle assets so typically 3-5yrs of decline then 3-5 yrs of bottoming (flat dull prices changes) then a rise again. West coast prices are way too high. FL still has abit to go.

[naples]

oops i posted the second one because i thought my first post was lost. sry guys for the close repeat.

i thought it was important i posted because few apparently understand how to value RE properly.

[tradersystemguru]

Your argument is nearly identical to one that tells us its time to buy stocks based on stock market valuations. Such an approach encourages people to double down on a bad investment and will cost you your shirt in a true bear market. And I think it is safe to assume based on the data, that the real estate market is in its biggest bear market since the 1930s...

Like Cramer advising his listeners to hold on to Bear Stearns on March 11 when the stock was trading at $63, telling people that now is the time to buy property without concrete proof that prices have stopped falling is just plain bad advice!

The way prices and the property market is going, prices could be back to late 1990's levels of affordability or earlier before that time will come.

[naples]

think before you post and dont compare me to cramer. i didnt retire based on the tech bubble like he did.

[Gary Anderson]

Dr Perry. Does PHD mean phony doctor? I mean, all this assumes no or little down payment. Entry level buyers do not have a chance. Or maybe you are looking at the savings rate of the Japanese by mistake. And by the way, the Japanese had 16 years of declining house prices with savings. What do you think could happen here?

I just have one question for you, phony doctor, are you a paid RE shill or do you just do it for free?? Lol.

[Christian]

I agree - affordability HAS increased. However, do I think we've hit an inflection point for another "housing bull market"?

Not by a long shot - I live in SoCal.