The current landscape of housing affordability is notably bleak, with factors such as the Federal Reserve’s swift interest rate hikes and the government’s hefty stimulus expenditures during the pandemic playing significant roles. Yet, the aim here is not to point fingers. Various factors, including demographic changes and a lack of sufficient new housing, have complicated the path to homeownership for many, especially first-time buyers. The goal of this conversation is to understand the Federal Reserve’s intentions and explore how individuals might navigate these waters.
To grasp the gravity of the affordability crisis, particularly for first-time homebuyers, it’s insightful to review several housing affordability charts.
Delving into the Housing Affordability Crisis
A chart from the National Association of Realtors illustrates the Housing Affordability Index since 1990, hitting a historic low as of July 2023. Bloomberg offers another chart that portrays this data in a more visually striking manner.
Additionally, a chart from the Atlanta Fed highlights the percentage of median income required for the median U.S. housing payment, which has soared to a new high of 43.8% from January 2006 to May 2023. The chart showcasing the mortgage payment to income ratio, factoring in a 20% down payment and not accounting for other costs, also indicates substantial growth.
A comparison between the average 30-year fixed-rate mortgage and the Housing Affordability Index since 1981 shows an inverse relationship: as mortgage rates climb, affordability plummets. Although lower mortgage rates from 1980 to 2012 improved affordability, a rise in home prices from 2012 to 2021, coupled with increased prices and doubled mortgage rates post-2022, has sharply decreased affordability.
Is the Federal Reserve Encouraging a Shift to Renting?
The data clearly shows that housing affordability in the U.S. is at a low point. Still, with around 66% of Americans owning homes and about 40% of those being mortgage-free, a significant portion of the population enjoys high affordability. The most affected by the escalating rates and prices are first-time buyers, particularly younger millennials and Gen Z.
Despite this, the Fed has raised the Fed Funds rate repeatedly since 2022 and may continue to do so in 2023, despite rising bond yields. This situation leads to speculation that the Fed’s goal might be to increase the number of renters to support the investor class, as home ownership becomes increasingly unattainable for the middle class and younger Americans, leaving renting as the sole option.
This widening gap could have profound socioeconomic effects in the future.
Trends in Home Prices Since 2020
The Fed’s aggressive rate hikes aim to curb or lower home prices to improve affordability, given the steep increase in home prices since 2020. However, this has resulted in a situation where both home prices and mortgage rates remain elevated, discouraging homeowners with low-interest rates from selling. Consequently, more Americans are leaning towards renting.
A chart by Lance Lambert from Fortune magazine highlights housing markets with the most significant price drops since 2020. While a decrease in home prices could be beneficial, a rapid decline might cause financial distress for recent buyers and adversely affect the overall housing market.
The Dynamics Between Homeowners and Renters
The Fed makes interest rate decisions with all data in mind, aiming to balance the economy. Considering the large percentage of Americans who own homes, with an increasing number owning additional properties for rental income, the Fed must ensure there are enough renters to maintain stable rent levels. This approach helps lessen reliance on government support for retirees, given the underfunded state of Social Security and the high cost of government benefits.
Although this might seem speculative, the trend towards owning rental real estate has been noticeable since 2009. With the stock market’s volatility, real estate emerges as a more attractive option for retirement income.
Renting vs. Owning Costs
The ratio of annual rent cost to gross income has hit a 20-year peak at 40.6%. This underscores that, despite the perceived high cost of buying, renting in the long term often ends up being more expensive due to the absence of equity accumulation.
Building a Rental Property Portfolio
Given the Fed and government’s apparent preference for homeownership, aspiring property owners should aim to secure their primary residence and at least one rental property. This strategy helps ensure future housing affordability concerns are minimized.
Steps include saving for a downpayment, making smart investments, advancing in your career, and being conscious of consumption. Additionally, investing in public REITs or private real estate funds and paying attention to local economic indicators can be beneficial.
Cash Flow vs. Property Values
For long-term rental property owners and retirees, rental income cash flow is more important than fluctuating property values. For instance, despite a decrease in property values, an increase in rental income significantly affects lifestyle and financial security.
Reflecting on a 2002 conversation with a San Francisco deli owner about the fear of being priced out of the housing market led me to buy a condo in 2003. This property now generates stable rental income, providing housing security and easing affordability concerns.
Given the potential for housing to become even less affordable, mirroring trends seen in the Canadian market, it’s wise to invest in real estate as early as possible to protect against inflation and economic growth. Looking back over a decade, this decision is likely to prove advantageous.
