13 October 2011

Home Ownership Affordability At 40 Year Plus Record

For the first time in more than thirty years the median monthly rental payment is the same as the principal and interest part of the median monthly mortgage payment. This is because mortgage payments have fallen from a high bubble level to something close to the pre-bubble norm since 2005 due to falling home prices and lower interest rates, while median rents have steadily increased almost every year for the last thirty years.

The median mortgage payments excludes some costs of home ownership that are included in rent, like property taxes, homeowner's insurance allocable to the structure, major maintenance costs, and home buying up front costs like closing costs and down payments that are typically greater than the security deposit and rental application fees paid by renters. So, renting isn't really no less expensive than owning.

But, the relative price of owning relative to renting has fallen in half in just half a decade. The median mortgage payment to median rent ratio was 3:1 in 1981, 1.5:1 in the mid-1990s, 2:1 in 2005, and is 1:1 now.

This is even more remarkable when you consider that stricter credit requirements and falling homeownership rates (from a near peak in homeownership rates of around 70% around 2005 to something close to 65% now) have made the ranks of those who are paying mortgages more elite, something you would think would lead to higher, rather than lower median mortgage payments. Also, the drop in homeownership has come almost entirely from the two-thirds or so of homeowners who have mortgages, not the one-third or so who own their homes free and clear. So, the proportion of people who pay mortgages now is down more than 10%. This is quite a bit more elite.

The trend in rents is equally puzzling. It certainly isn't surprising that rents have gone up as the number of people who are renting relative to the number of people who own homes has risen (an increase of roughly 1/6th from 30% of the population to 35% of the population), as new construction has ground to a halt (although presumably, more single family homes and condominiums have gone from being owner occupied to rented, picking up some of the slack), and as more affluent people who in prior years would have been homeowners revert to being renters. The surprise in the median monthly rental payment trend is that it has been rising so relentlessly over the last thirty years without any regard to prevailing economic conditions.

While the trendline for owner occupied homes has jumped up and down like the stock market, rental price trends have not changed in the slightest, despite the fact that they involve an identical commodity (sometimes the very some residence). In the time period from 1981-2011, there have been wild shifts in homeownership rates (which impact median renter income), interest rates (which impact rental real estate costs), housing prices (which impact rental real estate costs), the inventory of rental real estate, and more. The numbers are nominal rather than inflation adjusted, and at a glance actually seem to show a more gradual trend than inflation which is known for its ups and downs with the business cycle, perhaps offering proof that prices (or at least residential rents) are sticky in the rental market despite the fact that rental properties turn over and are subject to market discipline much more often than owner occupied properties. Alternately, this regular market discipline may be what makes this market, that determines a market price for a much larger percentage of the total inventory each year than the owner occupied home market, less variable.

Nominal median rents have not quite tripled in the last thirty years, while the consumer price index has risen by a factor of 2.49 in that time period. So, real rents are actually up a little less than 20% over the last thirty years - an increase of about 0.6% per year (an increase of about $4 for next year's rent relative to this year's rent after inflation for a median renter paying the current median rental income in 2011) on an annualized basis, which is pretty close to the thirty year trendline for working class incomes.

My intuition is that median rents are roughly tracking 20th percentile incomes which have been quite stable over the last thirty years - barely keeping up with inflation, rather than the variety of supply based factors that have influenced mortgage pricing. In other words, it appears that median rents are largely demand driven (i.e. driven by the ability of prospective renters to pay), while median mortgage prices are largely supply driven (i.e. driven by housing costs and interest rates), and that demand side factors have been more stable than supply side factors over the last thirty year period.

Viewed this way, the real story that we are seeing now is not rising rents, which are actually remarkably stable after adjusting for inflation and long term trends in median renter income, but falling mortgage payments caused by the housing bubble collapse and falling interest rates. It hasn't been this cheap to buy a home in a very long time, and tougher underwriting standards have prevented people from taking advantage of the more affordable prices and driving them up again.

Indeed, given how high median mortgage payments were relative to median rental payments in 1981 (an admittedly somewhat odd year when stagflation ravaged the economy), housing affordability may be at quite a bit more than a thirty year record right now. A look at housing affordability data going back to 1970, makes clear that housing affordability is at a more than 40 year low right now, surpassing the record set in 1972. It certainly isn't unreasonable to guess, however, that we are at a 45-55 year record for housing affordability.

And, as I've remarked before, before post-WWII government interventions in the mortgage market through the GI Bill, Fannie Mae and Freddie Mac, and the mortgage interest deduction, it was much harder to obtain a residential mortgage than it is today.

It may very well be cheaper to buy a home, for those who have the down payment and credit rating and regular income and low debt ratio to do it, than it has ever been in the entire modern history of the United States, although I wouldn't rule out a more affordable moment for returning veterans buying small Levittown style houses in the 1950s suburbs (historical statistics have their limits because it is hard to know how to compare situations like do it yourself house raisings on homesteaded properties and pioneer do it yourself shacks).

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