Volume 9, Number 1
First Quarter 2007
After the Boom, Housing Affordability a Growing Challenge
As Americans' rate of home ownership nears historical highs, home prices have risen simultaneously. Ensuring a supply of affordable housing for those aspiring to their share of the American dream remains a challenge in many areas, including the Southeast.
The housing boom may be over, but the high cost of housing remains a significant economic concern and a potential threat to the federal government's established policy goals of encouraging home ownership as an avenue for wealth creation and social stability.
Between 2002 and 2006, average housing costs nationally increased by about 10 percent per year or a total of 50 percent, according to the Office of Federal Housing Enterprise Oversight. That rate of appreciation is historically high but was even greater in certain markets, particularly in desirable waterfront locations and in fast-growing metropolitan areas. For example, house prices in Florida for the same five-year period increased by about 100 percent—more than twice the national average.
"Housing affordability has become a critical issue not just in the Sixth [Federal Reserve] District, but also nationwide," said John Wieland, founder and chairman of John Wieland Homes and Neighborhoods, which builds homes in Southeastern markets including Louisville, Ky., Charlotte and Raleigh, N.C., Charleston, S.C., Nashville, Tenn., and Atlanta.
Putting affordability into context
When evaluating housing affordability, residential appreciation is an important factor, but there's more to the story than price. A more complete measure of various aspects of purchasing a home is depicted by the Housing Affordability Index (HAI), which is constructed by the National Association of Realtors. The HAI is designed to capture important components of affordability, including home price, a home buyer's income, and the cost of a mortgage (see the table).
The HAI considers median household income data, which is collected by the U.S. Census Bureau. The U.S. median income for families in 2005 (the most recent year available) was $55,832, compared with $51,742 in 2002—an increase of about 8 percent over four years. Underlying the median family income is employment, and during this same three-year period the job market gained strength. From 2003 to 2006, nearly 7 million new jobs were created nationally, and the unemployment rate declined to 4.6 percent, low by historical standards.
While the additional paychecks have helped to sustain economic growth and support house price appreciation along with household income, median family income has grown at roughly the same pace as inflation. More importantly to the housing affordability equation, median income growth has not kept pace with the rate of house price appreciation in many places.
Along with income growth, demographic changes such as immigrant population growth and the retirement of baby boomers influence house price appreciation. Retiring baby boomers have been buying second homes and, in desirable locations within major markets such as intown Atlanta and Miami, condominiums as well. Also, the rapid growth in wages for many skilled jobs has boosted home prices in active job markets. At the same time, wages have stagnated for many lower- or unskilled jobs and in certain industries that have experienced layoffs, aggravating the recent increase in house prices.
In addition to median family income, the HAI also factors in qualifying income, which is the income required to qualify to purchase a median-priced home and is determined partly by the effective interest rate on mortgage loans that have closed on existing homes. While mortgage rates remain low by historical standards, they have increased in recent years.
However, even this modest increase in mortgage rates contributed to a sharp decline in housing affordability in 2006. With only moderate income gains and sharply rising housing costs, would-be home buyers were in a weakened position: The HAI went from 131 in 2003 to 106 in 2006—a 19 percent decline, indicating declining affordability. Depending on how the market adjusts to a sluggish housing sector, home buyers' position could strengthen.
Home ownership's societal impact
While housing market conditions vary widely depending on location, housing affordability has become an issue with broad economic and social implications because it has a direct bearing on home ownership.
In the United States, home ownership is considered a desirable economic outcome for many reasons. Families who own property are more likely to invest in their communities, and home ownership offers a path for individual families to save, which ultimately leads to more wealth and buying power, according to The Impact of House Price Appreciation: Portfolio Composition and Savings, a 2004 report from the Department of Housing and Urban Development. Home ownership can also lead to other financial advantages. For instance, households with mortgages generally have better access to credit and lower borrowing costs.
During the past decade, the rate of U.S. home ownership increased steadily as mortgage rates declined during a climate of low and stable inflation and new mortgage products were added to the financial services marketplace. With these conditions in place, home ownership has grown to the point where just under 70 percent of Americans own their homes. The home ownership rate has held steady for several years at a relatively high level, but the recent upward tick in mortgage rates along with the ongoing high cost of housing has placed downward pressure on the home ownership rate, which has stagnated for low- to moderate-income families with children.
To encourage home ownership, policymakers have approved various programs. For instance, the 2004 American Dream Act provides down payment assistance for low-income and first-time home buyers. Government sponsored enterprises such as Fannie Mae and Freddie Mac also target underserved borrowers and communities with the aim of making mortgages accessible to more of the population who otherwise couldn't afford a home.
Some home owners caught in a squeeze
New and innovative types of mortgages have brought home ownership within reach for many people who couldn't previously qualify for a mortgage. But some of the new mortgage products are untested by certain market conditions, and any additional leverage can bring more risk. "Since the mid-1990s, we've seen the extension of credit into the lower-income range, and subprime lending has increased," said Dan McCue, a researcher with the Joint Center for Housing at Harvard University.
During the past few years, lenders have reported rapid growth in mortgages that have low initial interest rates and monthly payments. But increases come later as the introductory period ends and the borrower has to begin making higher mortgage payments.
Affordability most affects those least able to buy a home. As housing costs increase, more families stretch their budgets and turn to alternative methods of mortgage financing, and affordability problems have become more widespread. The number of Americans who face housing-cost burdens (defined by the Joint Center for Housing Studies as those paying more than 30 percent of their income for housing, including taxes and insurance costs) increased by two million between 2001 and 2004, to a record 15.8 million, according to the center.
Affordability faces some obstacles
Clearly, strong demand for new affordable housing exists. But restrictions on residential development, including land use regulations that limit lot size and density, aggravate the problem of housing affordability in many locations.
In more costly metropolitan areas, these restrictions have made housing less affordable. In 2006, the median home price in the 202 largest metropolitan areas was about $248,000, according to the Center for Housing Policy. At that price, a home buyer would need an income of $85,000 to quality for a mortgage, assuming home buyers needed a 10 percent down payment and could afford to commit 28 percent of their income to mortgage payments, property taxes, and home insurance. In San Francisco, the nation's most expensive market, the median-priced home was $759,000, requiring an income of $260,000 to buy a home.
While house prices are lower in many Southeastern cities than in the rest of the country, concern is growing that many households with incomes in the median range can no longer qualify for conventional mortgages, according to the Center for Housing Policy. As affordability declines, more and more families face difficult choices.
Various federal, state, and local programs have attempted to respond to this situation by encouraging development of low-cost housing for rent or purchase. One option for making affordable housing more available is the community land trust, which is a nonprofit entity that acquires and holds land for the benefit of the whole community.
Also, some communities offer educators, police officers, or firefighters incentives to buy homes in the areas they serve. To the same end, with the decline in affordability, some hospitals are planning their own units to provide housing for health care workers priced out of the local market.
"The price of homes is of serious concern for the health care industry," according to the Center for Housing Policy's January 2007 report. If some skilled workers face difficulties owning their homes, the problems low-skilled workers confront is especially acute (see the sidebar "Housing Affordability and the Low-Income Worker").
Builders read the signals
While lower affordability may be one reason behind the slowed demand for purchased housing, the overall adjustment in demand generally has been orderly to this point. Homebuilders have responded to initial signals of weakening demand by easing up on the pace of new home construction. The number of single-family home permits nationally in 2006 was 1.8 million, down from 2.1 million in 2005, according to the U.S. Census Bureau.
Economists have noted that housing prices nationally are still high relative to rents and interest rates. As for the housing sector's broader impact, it supports a range of jobs and has been a major driver of economic growth, especially in the Southeast, where population and new home construction growth have exceeded national averages (see the sidebar "Home Price Trends in the Southeast"). Because declining affordability limits demand for housing, sustainable economic growth depends on an orderly adjustment in home construction and housing prices—an outcome that appears to be unfolding but is not yet a certainty.
With housing affordability declining and residential activity continuing to adjust at different rates in different locations, consumers face varied landscapes depending on where they live. Ensuring a supply of affordable housing remains a challenge in which developers, policymakers, and the public have a large stake.
This article was written by William R. Smith, a staff writer for EconSouth, with Julie Hotchkiss, a research economist and policy adviser on the regional team of the Atlanta Fed's research department.