All this week, we will be looking at the Housing Recovery meme, challenging the assumptions and data that make up that argument. Yesterday, we began with Debunking the Housing Recovery Story (Part 1 of 5). Today we look at exactly how affordable homes are today, as well as the home buying public’s ability to afford them (Home Affordability/Employment & Wages).
Today, we are going to take a closer look at Home Affordability — and we learn that homes are not in fact very affordable at all.
We begin where nearly every other conversation about home affordability seems to start — with the National Association of Realtors (NAR) Home Affordability Index.
We first looked at this index back in August 2008, in a post appropriately titled NAR Housing Affordability Index is Worthless. Why did I come to such a harsh conclusion?
“The index as presently constructed is utterly worthless. It provides little or no insight into how affordable US Housing actually is . . . As hard as this might be to imagine, it shows that over the course of the biggest run up in housing prices in American history, the Index remained perfectly affordable. Except for one monthly reading of 99.55 in late 2005 — a smidge below 100 — housing never dipped into the level of unaffordable over the entire giant housing boom.”
So the entire run up preceding a 35% drop in prices, the NAR HAI had but one month where homes where not deemed affordable. As ridiculous as that sounds, its even more absurd when we take a look at the NAR methodology:
“The index ignores factors like family savings rates, available cash assets, consumer credit, indebtedness, credit servicing obligations, inflation, income gains, and mortgage availability.”
The kindest thing I can say about the Affordability Index is that it lacks context. Hence, it looks at the wrong things and ignores the important ones. The question is not whether, in the abstract homes are theoretically affordable; Rather, the correct question is whether potential buyers can afford homes. Ignoring this as it does means this is a meaningless metric for assessing the most important question of all when it comes to a US housing recovery: Whether or not people living in America can afford to purchase homes located in the same nation.
Sure, houses in the US are affordable to cash-rich Martians visiting Earth looking for a place closer to the Sun. But, not surprisingly, little green men with lots of cash are not what will be driving any US housing recovery. We can say the same about cash-rich Asians and South Americans (and any Europeans assuming the Euro is still around).
Why does this matter?
In the real world, the home buying process begins with two key financial factors: The potential buyers down payment, and their ability to qualify for a mortgage.
In today’s world, most American families are cash poor and debt rich. They are deleveraging, not saving. They simply do not have the $40,000 that is the standard 20% down payment on the median priced US home.
Those that do have the extra cash must then meet the next hurdle: Qualifying for a mortgage. This means they must have a good credit score, not be carrying too much debt, have a steady income, etc. (Even those that qualify must then make sure that their house appraises at the sale price, but that’s a latter discussion).
Regardless of the fact that homes are off 35% from their peaks, and mortgage interest rates at record lows, buyers have an insurmountable hurdle. For most potential home buyers, the NAR Home Affordability Index is a meaningless data point. Lacking any down payment and having restricted access to available mortgage credit, homes may be theoretically affordable — just not to them . . .
Tomorrow: The problem with Mortgage Rates
NAR Housing Affordability Index is Worthless (August 13th, 2008)
NAR: Methodology for the Housing Affordability Index
10 Responses to “Home Affordability Reality Check (Part 2 of 5)”
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Interesting that property taxes are conspicuously absent from any discussion around real estate affordability, valuations, regional patterns. I guess it must just be too difficult to analyze such a complex topic or be a completely irrelevant factor when people purchase a home. Odd because where I live, I pay more in property tax than any other type of tax, income, sales or otherwise.
I completely agree about property taxes being an important factor in affordability. In our town we have people paying as much as $4,000.00 per month and as little as $600.00 per month just in property taxes. Over the past 8 years property taxes have doubled, some have tripled. All the while a major gift was being given to wealthy apartment building owners who saw their tax rates decline from 33% of fair market value to 10% of fair market value. This gifting to the 1% is going on at the local level too.
To R & P: It seems to me the article was focused on acquiring a property and not ongoing cost of ownership; initial taxes are estimated at settlement whether escrowed or not. If taxes were to be added to the analysis, so must house condition, insurance costs, new travel patterns requiring gas or out of pocket public transport, township/local government history and population growth rate and spending/tax forecasts among other things. Even micro climates count. Post acquisition costs (and income risks) are myriad, and often lost in the glow of new home ownership, which is probably a good thing or few would make the jump.
Given that property taxes and insurance (fire, and mortgage up the 20% line) are mandatory parts of any mortgage payment, they go directly to affordability.
Tracking NAR "studies" is useful in one respect: You can see where the next round of newspaper and television opinion pieces come from.
As a current renter and potential buyer, I am skeptical of the return on investment of home ownership for an "ordinary guy" (purchase 1 home and live in it). For me, purchasing a home with the mentioned $40,000 down payment would be putting nearly all my eggs into one basket just for the down payment. When I thinking about all the post-purchase costs required to maintain and upgrade the home, I am more inclined to think I would get a better return in other asset classes.
On another note; for those of us whom a home purchase would require the majority of our savings in the form of a down payment, this represents a liquidity problem. To me, this is unaffordable and I'd rather be a renter with $40,000 in stocks, bonds and other more liquid assets.
On another note; for those of us whom a home purchase would require the majority of our savings in the form of a down payment, this represents a liquidity problem. Seattle Real Estate
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