Well, well, well, now that the Federal Reserve’s rate hike program has finally broken something (Silicon Valley Bank, Signature Bank, and possibly now First Republic Bank too…) they might be forced to back off. The winds of prevailing opinion have suddenly shifted: the tightening cycle is over! Looks like QE’s back on the menu, boys! Believe it or not this might be great news for the legions of people in our country who can’t afford anything anymore, particularly when it comes to housing.
The Rates are too High!
Consider that the biggest showstopper to housing affordability is interest rates. Sure, today’s average rate on a 30-year fixed-rate mortgage, 6.62%, is average by historical standards, but the home-price-to-income ratio is 6:1, far higher than historical standards (from the 1950s through the 1970s it hovered around 2:1). As such, people can’t afford 6% mortgages.
One might think prices would come down to compensate, but something like 40% of all homeowners have locked in sub-3% rates from right after the pandemic; they’re not moving unless they have to, which chokes inventory to a bare trickle, keeping prices high even as interest rates skyrocket. Furthermore, even without this factor there’s a shortage of millions of housing units compared to demand, which keeps prices high and rising. Many have commented on the absurdity of only the top 20% being able to afford a house, but if there are only enough houses for 20% of the public and they’re sold to the highest bidder the prices will tend to converge to what the top 20% can pay. Together with the high rates it makes for a double whammy of unaffordability.
Light at the End of the Tunnel?
There are only three ways to redress this situation: flood the market with new supply (thus lowering prices), lower the interest rates (so a given price has a lower payment), and raise wages (so a given payment is more affordable). Fortunately, we might see all three simultaneously in the near future, a triple whammy in favor of housing affordability.
The Fed will likely back off any further rate hikes, but bar a serious economic crash we won’t be seeing rates cut to the basement again until inflation ebbs, which will happen with or without any rate hikes. The inflation we’re seeing is a downstream effect of the COVID-19 lockdown policies (all those people who normally make the things we buy were instead sent home…), which should go away in the near future once we feel the downstream effects of the great reopenings (in this regard, by the way, the inflation we see now is much more similar to the 1940s demobilization than the 1970s stagflation; rate hikes don’t help). At that point it’s well possible that inflation will drop like a rock, potentially even, as some analysts predict, to outright deflation; although it’s a bumpy road, there are already clear signs that inflationary pressures are ebbing.
We’ve seen record real wage shrinkage during the inflation crisis, but that’s purely a product of inflation running so hot. In nominal terms wage growth and economic growth are both doing stupendously well by historical standards. Once prices start flatlining or dropping the economy and people’s paychecks in real terms should take off like a rocket, making today’s rent levels steadily more affordable.
Interest rates likely follow inflation back to the basement, bringing back those sweet 2.5% mortgage rates. A lot of those homeowners with low-rate mortgages will come forward, flooding the housing market with new supply. Housing construction, especially for multi-family units, has been spiking recently, which should bring further supply online, keeping the shortage more in check than it has been in the past few years, even if it will remain acute for the time being.
That might change over the long haul, however, and for the better; the state of California’s newfound embrace of “YIMBY” policy is a finger in the wind, and is already having significant and positive effects in the areas hit hardest by the affordability crisis. Other states are making moves to follow suit. “The abundance agenda” of “supply-side progressivism” is gradually turning on the spigots across the country, greatly increasing the odds that whenever the Fed’s “money printer go brr” again there will be enough new supply to absorb the resulting new demand without massive increases in prices.
Today’s Price Tiers
In even the second- or third-rate cities $300,000 is about the bare minimum to buy a home. At today’s rate of 6.62% that’s $1,920 a month in principal and interest. You need income of $86,000 a year to afford that. That’s significantly above the median household income, just to barely afford a crummy podunk house. Depressing, isn’t it?
Even up to the $600,000 price point in these places all you can get are merely above-average houses that regular ol’ people on middling incomes afforded 20 or 30 years ago if they stretched their budgets a bit. A $600,000 home loan at 6.62% will cost you $3,840 a month; to afford that you’ll need $172,000 a year of income. In the sort of cities you can get a house like this for $600,000 there are very few jobs that even pay that much, period. And even if you can find a diamond in the rough, one has to wonder what the point even is; you work so hard, come so far, try so hard, only to end up in the same place your grandfather was in with a tenth as much effort. All very demotivating.
The bright Future of Housing Affordability?
But let’s say the scenario I’m talking about comes to pass. Prices flatline or even decline somewhat; let’s say 10% down from here. So the $300,000 house is now a $270,000 house. That 6.62% interest rate is now a 2.5% interest rate. The payment on a $275,000 house at 2.5% interest? $1,087 a month. To afford that you need an income of $55,000 a year. Now that actually sounds realistic! Indeed, it’s considerably below the median household income.
But wait! Remember, wages are rising, to the tune of 6% a year. Let’s say these nominal wage increases convert to real wage increases; over the course of 5 years, that means 34% higher incomes for the same workers in the same jobs. Someone making $41,000 a year now ($20 an hour, assuming full-time work) will be able to clear the benchmark to get a starter home in a second- or third-rate city in 5 years’ time. That’s barely more than half of the median household income; indeed, most single income earners make that kind of money.
The $600,000 house? Shave 10% off the price; now it’s a $540,000 house. At 2.5% interest the payment on it is $2,134 a month. To afford that you need an income of $110,000 a year. A bit steep, but not unreasonably so; a somewhat premium income now barely affords you a somewhat premium house. But wait, it gets better! 5 years hence, someone making $82,000 a year now will be making enough money to afford it. That’s only modestly higher than the median household income.
It’s worth noting that $600,000 still can buy you a decent if modest home in a high-cost area like Greater Los Angeles; if that tier of housing opens up to median-income households the decades-long creeping geographic lockout from high-cost-of-living areas will largely reverse itself. Demographically, the US workforce is starting to shrink, so a booming economy should finally give us the much-anticipated “great labor shortage”; jobs might be easy to come by, aiding workforce participation, household formation, and, most critically for this scenario, geographic mobility. All those people priced out of California will flood back in under the YIMBYist rule of supply-side progressivism’s abundance agenda.
Conclusion
Admittedly this is a rosy scenario, particularly for me. I’m on track to earn a good income in a few years, and my leveraged stock portfolio grows my wealth such that I will reach my lifestyle goals…but decades later than I’d like to. To reach them by my forties I need a financial miracle on top of all that, and a combination of the 2010s bull market in stocks continuing for another decade or two and housing costs flatlining over the same period would be just that.
So I might be biased in my analysis by some wishful thinking. Nevertheless, I suspect the 2020s economy I outline here, where rate cuts, wage growth, and new supply all conspire to end the housing crisis, is much more likely than people seem to think it is. Watch this space.