The current state of housing affordability is alarmingly low, and factors like the Federal Reserve’s rapid rate increases and the government’s excessive stimulus spending during the pandemic have contributed to this situation. However, this discussion isn’t about assigning blame. There are numerous elements, including demographic shifts and insufficient housing construction, that have made it difficult for many first-time buyers to own a home. Instead, this discussion aims to comprehend the Federal Reserve’s objectives and how consumers might adapt.
Let’s start by examining housing affordability charts to grasp the severity of the situation, particularly for first-time buyers.
Understanding the Housing Affordability Crisis
A chart from the National Association of Realtors displays the Housing Affordability Index since 1990, showing a record low as of July 2023. Another chart by Bloomberg presents this data more dramatically, appealing to those who prefer a visual impact.
A third chart from the Atlanta Fed illustrates the U.S. median housing payment as a percentage of median income, which has reached a new peak of 43.8% from January 2006 to May 2023. The mortgage payment to income ratio chart, considering a 20% down payment and excluding additional costs, also shows significant increases.
Finally, a chart comparing the average 30-year fixed-rate mortgage with the Housing Affordability Index since 1981 reveals an inverse relationship: higher mortgage rates equate to lower affordability. Despite a decline in mortgage rates from 1980 to 2012 enhancing affordability, a surge in home prices from 2012 through 2021, followed by elevated prices and doubled mortgage rates after 2022, has led to a steep decline in affordability.
Is the Federal Reserve Aiming for a Renter-Dominant Nation?
Given the data, it’s evident that housing affordability in America is low. Yet, approximately 66% of Americans own homes, with about 40% mortgage-free, ensuring high affordability for many. However, first-time buyers, particularly younger millennials and Gen Z, are most affected by the higher rates and prices.
Despite this, the Fed has raised the Fed Funds rate multiple times since 2022 and might do so again in 2023, even with rising bond yields. This raises the possibility that the Fed’s aim might be to increase renters to support the investor class, as fewer middle-class and young Americans can afford homes, leaving renting as their only option.
This growing divide could have significant socioeconomic implications in the future.
Home Price Trends Since 2020
Aware of the substantial rise in home prices since 2020, the Fed’s aggressive rate increases aim to temper or reduce home prices, making them more affordable. However, this has led to a scenario where both home prices and mortgage rates remain high, causing homeowners with low-interest rates to hesitate to sell. As a result, more Americans are pushed towards renting.
A chart by Lance Lambert of Fortune magazine shows housing markets with the most significant price declines since 2020. While a reduction in home prices can be positive, a too rapid decline could lead to financial hardship for recent buyers and negatively impact the housing market overall.
The Interplay Between Homeowners and Renters
The Fed, considering all data, makes interest rate decisions to balance the economy. Knowing a large proportion of Americans own homes and an increasing number own additional properties for rental income, the Fed needs to ensure sufficient renters to sustain rent levels. This helps reduce government dependency for retirees, considering underfunded Social Security and costly government benefits.
This might sound speculative, but the trend towards owning rental real estate has been noticeable since 2009. With the volatility of stocks, real estate becomes a more appealing retirement income source.
The Cost of Renting vs. Owning
The annual rent cost to gross income ratio has also reached a 20-year high of 40.6%. This highlights that, despite the perceived unaffordability of buying, renting over the long term is often more expensive due to the lack of equity building.
Building a Rental Property Portfolio
Understanding the Fed and government’s favoritism towards homeowners, aspiring property owners should aim to acquire their primary residence and at least one rental property. This strategy ensures future housing affordability is less of a concern.
Steps include saving for a downpayment, investing wisely, advancing in your career, and being mindful of your consumption. Also, consider investing in public REITs or private real estate funds, and keep an eye on local economic factors.
Cash Flow vs. Property Values
For long-term rental property owners and retirees, cash flow from rent is more crucial than the fluctuating property values. As a personal example, despite a decline in property values, increased rental income has a more significant impact on lifestyle and financial security.
The Future of Housing Affordability
Reflecting on a conversation in 2002 with a deli owner in San Francisco, the fear of being priced out of the housing market led me to purchase a condo in 2003. This property now provides a stable rental income, creating housing security and mitigating affordability concerns.
Considering the possibility of housing becoming even more unaffordable, as seen in the Canadian market, buying real estate as early as possible is advisable to hedge against inflation and economic growth. Over a decade, this decision is likely to be beneficial.
