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It's NOT about housing affordability

By
Real Estate Broker/Owner

For the past three years economists and the media have been proclaiming that homes were simply too expensive, that nobody could afford to buy a home, and that  once housing became more affordable and home values declined, more Americans would be able to achieve the dream of homeownership. 

Well, that "philosophy" isn't exactly working that well, if you've been watching the events of the past year unfold, there have been some very serious ancillary side effects to this somewhat lethal prescription for housing affordability.

According to the National Association of REALTORS and their housing affordability index, in November of 2008, before rates really plummeted to historic lows in January, the composite (fixed and ARM) housing affordability index was already at 142.4, this is the highest on record since 1973 when the index peaked at 147.9.  As a frame of reference, in 2005 when existing home sales hit an all time high with over 7 million units being sold, the affordability index was only 111.8.  At the time, that was the lowest affordability index since 1986. 

In case you were wondering the housing affordability index measures income, home price, as well as mortgage rates. 

Despite housing affordability hovering near historic highs, the housing market is collapsing as it sinks into the worst downturn since the great depression as there is currently an 11.2 month supply of housing, the highest on record, this despite the fact that home values have already plummeted 18% from their high in 2006.  Existing home sales are at a 4.5 million annual pace, the lowest since 1997 (source: NAR).  New home sales are at an 433,000 annual pace, the lowest since 1982 (source: Department of Commerce).

The point is that allowing home values to continue to erode as a result of the supply and demand imbalance is not going to "cure" the real estate market.  It's not about affordability.  Unfortunately, continued property value declines are exactly what is going to happen based on current market conditions and the number of foreclosures that will be coming to the market over the next four years.  Home values are going to continue to decline precipitously bringing the broader economy down with it, yet housing affordability will shatter historic norms.

What the proponents of "housing affordability" and lower home values have overlooked is that there simply are not enough buyers that have the credit and capital that can enter the market and make a dent in the excess housing inventory which is a result of home value declines and foreclosures.  Homeownership rates are still hovering near 68%, well above the historic norm of 64%.  In other words, the "cancer" of declining property values which is turning into an epidemic, can't also double as the cure for saving the housing market in the name of "housing affordability".  The housing affordability index proves this.

 

 

 

 

 

 

Comments (5)

Paul Francis
Francis Group Real Estate - Las Vegas, NV
Las Vegas Real Estate Agent - Summerlin Homes

Unfortunately the artificial appreciation created by the giant pool of money and lax lending standards has come back to cause more problems then it was worth...

You are right.. it's not about affordability anymore... it's about people saddled with debt and bad credit due to the spending spree of all the money available during the boom.

Oh... building a bunch of homes to meet the artificial demand certainly did not help either....

Jan 16, 2009 04:33 AM
Associate Broker Falmouth MA Cape Cod Heath Coker
https://teamcoker.robertpaul.com - Falmouth, MA
Heath Coker Berkshire Hathaway HS Robert Paul Prop

Affordability is a measurement index that does not include enough variables to be correct or useful.

Jan 16, 2009 04:59 AM
Mark MacKenzie
Phoenix, AZ

Paul:  I agree with everything you are saying.  The point I want to make in this post is that allowing home values to fall further, as many are calling for in the name of affordability, is not going to turn the housing market around.

Heath:  I agree that there are a lot of other factors that impact one's ability and willingness to purchase a home.  That being said, this index is a metric that provides some context for the current housing environment.  I wanted to bring it up because it provides a frame of reference as to why allowing home values to continue their free fall will not likely have any net stimulative impact on the housing market.  And this is all the more reason as to why a real housing stimulus plan would be a good part of a broader economic plan. 

Jan 16, 2009 08:34 AM
Chris Olsen
Olsen Ziegler Realty - Cleveland, OH
Broker Owner Cleveland Ohio Real Estate

Another very insightful post Mark.  Very clear and right on.

I think until REAL people have REAL and STABLE jobs, any solution, at best, will be momentary and not a bedrock which the low and middle classes need.

Jan 16, 2009 04:33 PM
Anonymous
Donavan

I think you misunderstand what Peter is saying by "affordability". Just like in every other asset, affordability is typically used as a synonym for "market clearing level". If the prices drive down until the supply is cleared, you have a working market again. A properly working market does not require rising prices to be healthy. This is one of the greatest lies that our government has ever told us.

 

You generally lean too much on 2 numbers: The affordability index and the number of buyers in per year. The affordability index is not the end all be all, and, as has been proven, the vast majority of the real estate issues are in California and Florida. I'd be curious how home prices compare with median incomes in those markets. What you'll most likely find is that, although the national median may look low, the mean is horribly scewed because of all of these issues at the top-end. This number also ignores household leverage. Part of our problem right now is that even renters have a large leverage rate for other things like unsecured credit card debt or cars. For many of these people, houses are still not affordable. In order for these buyers to come into the market, the price has to be below the standard median prices. Remember, these price indicators ignore levereage rates. As a country, we ignored leverage rates for far too long, and now that debt is being considered, debt-adjusted affordability should be measured and tracked very closely. The picture shall start to change shape dramatically.

The second number you lean on is the average number of buyers per year. This is a fine number to track general trends over a long time frame. However, this number is nowhere near static. That's like saying that, per year, 6 million people buy pickles. If pickles have an average price of $5 per jar, sure. But, if you have a drastic oversupply of pickles, you need more buyers to clear out the inventory. So what do you do? Drop the price to $1 per jar. All of a sudden, for that year, you don't have 6 million buyers, you have 12 million. My point is if the real estate market must clear out inventories, then they have to price the property approiately. If you rpice it right, buyers will come.

 

The primary problem with establishing a market clearing level for housing prices is that the true market clearing level for these assets is far under the amount of leverage taken on them. So private sellers with high leverage levels can't sell the property  because they either refuse to actualize the loss on the asset or they can't obtain the margin financing to get out from under it. The end result most of the time is foreclosure. However this is a _good thing_.  As many people have said, this bad debt must be cleaned out. The institutions who underwrote that bad debt need to go bankrupt, the losses must be born on the shareholders and bondholders of these firms, and the whole thing laid to rest.

 

Government, at this point, has only tried to prop up these prices to try and protect people who made bad decisions and encourage others to invest in the loss. I can find, in this market, only one thing that the government can do to assist housing. Many of these mortgagees could never afford to pay their principal, or used HELOCS to ensure that they never got above water. However, most of the time, there's no real reason why these people cannot occupy their home.  What can be done is for government to promote private real estate trusts or other capital providers to buy these houses, then rent the house back to the occupant. The occupant stays in the home, promoting stabiity and confidence, and the capital provider now has assets without the bad leverage and an income stream based on those assets. BTW, those trusts would be good investment vehicles for people looking for growth opportunities in asset markets. The loser in this arragement is the bank. However, the bank was the entity that took the risk in the first place. That's where the loss properly belongs. (Now, to a certain extent, the homeonwer loses, as their credit will be damaged based on the default of their debt and they no longer have the backing asset, but they really have a clean slate, and don't need leverage any more than they need a hole in the head.) These banks will go bankrupt, shareholders get wiped out, and we start from scratch.

 

To your final point, one hard lesson we must learn from this is that housing is for the most part a _comsumption_ item, not an _investment_ item. The bubble made us think that black was white and white black, but the skies should be clear now. The land cost, which is the only apprecating part of a house, helps to offset, but not completly, the upkeep costs. A house doesn't get any more valuable by just sitting there: It requires labor for it to maintain its value, and even more labor to make it better, to appreciate. Therefore, the natural concolusion that can be drawn here is that it was your labor that made you profit, not the asset. The true economic production was your own effort. The saddest thing here is that people poured all of their savings into what became a consumption item, since they didn't spend any time improving the property (a common theme in a large part of the housing market; and, no, paying someone else to improve the property does not result in a net gain for the property holder. In fact, it's a net loss.) These people should learn a powerful lesson on savings, leverage, and hard work, and it should come at the expense of the banks, who should learn a powerful lesson about fruality and ethics. And everyone should teach the government a lesson: STOP SETTING THE STAGE FOR THESE PROBLEMS, STOP CONSIPIRING WITH BIG BUSINESS TO ENCOURAGE RECKLESS BEHAVIOR THAT BANKRUPTS US, AND STOP LEVERING UP!

Jan 25, 2009 06:19 AM
#5