The challenges of affordability measures at very low interest rates

Home Price analysts have been remarking how home price gains have out-stripped income over the last ten years, leading to ever-worse affordability measures over that time frame. As housing continues to become a hotter political topic, and as affordability may impact appetite for, and prices of, homes, I think that it might be worthwhile for home price index traders to take a take longer-term perspective, and a quick look at affordability inputs, to see what affordability is actually telling us.

First, while it may seem random to choose a 10-year look-back, recall that 2009 was the depth of recession where home prices had yet to bottom. Yes, home prices have risen dramatically since then, but a longer-term look at affordability suggests that today -given the sharp declines in interest rates - housing is more affordable that any time before the home price bubble popped. (This comes from someone who traded GNMA 15% MBS at prices below 100). A review of 15, 20 or 25-year history would not support the argument that housing today is un-affordable (on an absolute basis).

Second, given the very low level of interest rates, small changes in rates continue to generate large percentage changes in affordability. For example, in the table below a hypothetical decline in mortgage rates from 4% to 2% would have the impact of increasing affordability to Financial Crises levels. While such a drop would be a 50% change in the level of interest rates, a) it seems plausible given negative interest rates in other countries, b) deflationary concerns from lower-cost use of robots, and c) seems much more likely than the move in incomes (+~29%) or drop in home prices (23%) that would be required to give the same affordability result.

Finally, a concern for those citing housing affordability as the proxy for access to housing, would be a recessionary outlook where interest rates fall, in conjunction with a decline in home prices (due to drops in wealth and/or consumer confidence from the cause of the recession) while average nominal incomes, for those that retained jobs, remained flat. ( A common economic issue is the stickiness of wages in a deflationary environment). Under such a dire scenario, housing might climb to near all-time affordable levels, but optimism for homeowners to buy, might be severely constrained.

Net, I think that we have to take what affordability is saying with ever-more caution, as interest rates fall. Yes, a decline in rates might convert into pops in affordability, but not necessarily in higher home prices.

Feel free to contact me about this blog or any aspect of hedging home price indices.

Thanks, John