"Affordability Has Been Declining": A Discussion of Housing Affordability

1/13/2022

Tom Heintjes: Happy New Year, and welcome to the first 2022 episode of the Economy Matters podcast. I'm Tom Heintjes, managing editor of the Atlanta Fed's Economy Matters magazine. I'm so happy to be back in the recording studio and surrounded by my Bank colleagues, and I'm so pleased you're with me today because we're going to talk to the Atlanta Fed's Domonic Purviance, a subject matter expert in the Bank's Supervision, Regulation and Credit Division. We're going to discuss housing affordability trends as viewed by the Atlanta Fed's Home Ownership Affordability Monitor—or HOAM, as it's known. Welcome back to the podcast, Domonic—it's good to talk to you again.

Domonic Purviance: It's good to be here, Tom.

Lali Shaffer and Douglas King, both of the Atlanta Fed,  recording a podcast episode.

Domonic Purviance of the Atlanta Fed's Supervision, Regulation, and Credit Division. Photo by Ted Pio Roda.

Heintjes: Domonic, let me start out by asking why the Atlanta Fed tracks housing affordability, and how does that align with our work in bank supervision?

Purviance: Well, housing affordability is normally the leading indicator of where the housing market cycle is. Once housing becomes unaffordable, then that leads to increased risk in the housing market—people tend to borrow more than they can afford, their lenders tend to loosen credit standards in order to get more people to buy. That's normally an early indication that the housing market is actually entering the peak of the cycle, so we track it in order to make sure that we understand where risk is in the market, and the potential risk that our lending institution may be exposed to as a result of lending in the market at the peak of the cycle.

Heintjes: Right. And before we go much further, I want to ask you how we define "affordability." Is there a widely used metric, like the percentage of income going to mortgage payments? Just describe the yardstick we're discussing here.

Purviance: Yes, that's a good question. There's a distinction between "unaffordable" and "expensive," because those two things aren't necessarily the same. You could have a market like Washington DC, where the median home price is maybe $450,000 or something like that. It's more expensive than the national median home price, but incomes are higher there. If you're trying to define it, "affordability" is more accurately defined as the percentage of income versus how expensive the house is. The metric that we use is as defined by HUD [the US Department of Housing and Urban Development]. If you exceed 30 percent of your annual income in your principal, interest, taxes, and insurance, then purchasing that home is considered unaffordable. We focus on the median income household within a particular geography, whether it's overall US, a metro area, or a county. And if the median home price—the cost to own the median home in a particular market—if that exceeds 30 percent of your income, it's considered unaffordable. If it's below 30 percent of your income, it's considered affordable.

Heintjes: That's a great point: expensive does not always mean unaffordable. Domonic, the Atlanta Fed introduced HOAM, the monitor we're discussing, just as the pandemic was gripping the economy—in March 2020, in fact—so it was in the works well before COVID hit. And I guess no one could have foreseen the sort of changes in affordability measured since then.

Purviance: No, no. When we introduced the index, obviously we weren't expecting a year or two long pandemic.

Heintjes: Yes, no one foresees a pandemic.

Purviance: No, not at all. And to be quite honest with you, what we were expecting to occur in the housing market is quite different than what actually happened. We were expecting demand to decline or to be…we were looking back to 2008, and expecting something similar. That did not happen. In fact, the exact opposite happened…demand increased for a variety of reasons—one of which is interest rates were very low, so that was the impetus for a lot of people to buy. Also, people wanted more space—they were working at home, they needed office space, they had their kids at home—and so we really experienced a spike in demand. At the same time, there were a lot of people who decided they didn't want people walking through their houses, and they didn't think it was a good time to sell. So you had inventory taken off the market, builders couldn't build homes fast enough—all of those things came together and created this enormous upward pressure on home prices. And there was no corresponding increase in incomes, and so as a consequence, affordability has been declining by double digits for most of this year.

Heintjes: I want to talk for a minute about the monitor itself. What's involved in monitoring housing affordability on a nationwide basis? What data inputs go into it?

Purviance: Well, the most important data inputs are obviously the median home price, which we get from other sources—we use a three-month moving average to smooth out some of the volatility. Things like interest rates, taxes, and insurance are things that are available publicly. We also do some projections of income. Incomes aren't necessarily tracked every year, so we have to project incomes out. Those are the primary components. It's a significant undertaking to track this at the national level, and our index not only looks at the nation and metro areas, we also go down to the county level within metro areas. So it's a significant amount of data, and we hope to get even lower levels of granularity in the future.

Heintjes: Such as what? What would be an example of "even more granular?"

Purviance: ZIP codes, probably—being able to track what's affordable by ZIP codes within metro areas. Typically, how people think about housing markets is in smaller geography—"I want to buy in this ZIP code, or be in this school district"—so understanding housing and affordability at lower levels of geography is necessary for really understanding the health of the market, and in the big picture. In the future, that's probably something that we're looking to include.

Heintjes: And just to clarify, what does the monitor—the index—observe: homes with mortgages, or rental homes and apartments, or what specifically?

Purviance: We're just talking about homes for sale.

Heintjes: Right, okay. Well, we've all seen some remarkable data concerning housing affordability in recent months, as you alluded to. Your last home update noted that nationally, home ownership affordability fell 11.5 percent in August year over year—the sharpest decline in nearly a decade. That's amazing—what should we take away from trends like this?

Purviance: Well, what's interesting is affordability has been on our radar for some time. I think what we are experiencing—what we have experienced over the past year—is an acceleration of a trend that's been a long time in the making, and it's primarily been driven by what I perceive as a lack of inventory. We overcorrected from the 2008—at least, in the near term, overcorrected from the 2008 downturn, where we weren't building as much housing as population growth and demand would warrant. And there are a lot of people who refinanced their mortgages and they're locked in at a very low rate, so there's a disincentive for them to put their house on the market. So inventory levels have been declining over an extended period of time, and we haven't been able to replace it. And so, even though nationally housing was affordable—if you look at our index over the past several years up until this past year—it's been a concern of ours, and the current trend is just an acceleration of what we've been seeing. But of course, housing isn't the only thing where we're seeing a considerable amount of inflation. There's inflation everywhere. I just think the big takeaway is, this is a part of a long-term trend but also a broader trend that we're seeing in other areas of the economy as well.

Heintjes: Well, you mentioned that heightened demand is a driver of declining affordability, but what other factors are at work here? You mentioned the pandemic caused new home construction to slow down. Are there other factors that we should be aware of?

Purviance: Yes, one of the big things that happened—again, this is not a new trend, it just has been accelerated through the pandemic—there are a lot of people in high-cost markets that built up a lot of equity, particularly through the pandemic. As home prices went up, they were able to sell their homes and move to lower-cost markets. So this movement of…let's say if you're in the Southeast, you have a lot of people moving from the Northeast—New York, New Jersey—they had a lot of equity in their home, they would sell their homes and come with a lot of cash. And so, they're either paying cash for the home or they have a significant amount of cash to bring to the closing table. A significant amount of people have been paying well above asking price because they have a considerable amount of cash. All of that has accelerated this upward pressure in price. The other thing that's really driving this—I mentioned low interest rates driving demand. The other thing is nonprimary demand—people who are buying an investment property, people that are buying a second home, or institutional investors that are buying properties as part of an effort to build a rental portfolio. That's actually been one of the things that, as we talk to market participants, one of the big trends has been an influx of institutional investment, especially in our District—people looking to buy homes as part of a long-term strategy. Not like we saw during the last cycle where it's "fix and flip." There's some of that, but this cycle is more "buy and hold," and it's a play at acquiring rental properties.

And so you have all of this—you have people who are taking advantage of low interest rates, you have people who have equity in their homes, they're able to sell. You have institutional investors. All of that has just created this influx of demand in a market that as of today is critically undersupplied. All of that has created a situation where affordability has experienced significant downward pressure.

Heintjes: I was going to ask you how this situation differs from what we saw in 2008 and ‘09, so thank you for clarifying that. I'm a regular visitor to the affordability index that you produce, and a couple of things that always seem to be true: metro areas like Youngstown, Ohio, and other Rust Belt cities will have some of the country's most affordable housing, and places like San Francisco and San Jose will have the least affordable housing. For the sake of our conversation, let's take the high and the low off the table and talk more about median metros. Are there factors that they have in common, in terms of things like geography, economic conditions, demographics, or anything like that?

Purviance: Well, I think with the markets that are not in the extreme, what you're seeing is a transition from being affordable to being unaffordable. So you take some markets in our District, like Nashville. Nashville is a market that has attracted an influx of people from either the West Coast or the Midwest—markets like Chicago. People are moving to Nashville, and that market over the past several years has become more expensive, and so just in the last couple of months as we track affordability in a market like Nashville, we've seen Nashville go from affordable to unaffordable. Or, you take a market like Atlanta. Atlanta, based on our index, is still just above that affordability threshold, but affordability in Atlanta has declined by 16 to 17 percent over the past year, and that's the sharpest decline in our District. And so even though these markets don't show up on the extremes—they're not the most unaffordable or the most affordable, like Youngstown or San Francisco—these markets are rapidly transitioning.

I would also mention a lot of our markets in Florida, which were traditionally seen as affordable alternatives for people who are moving from the Northeast and for retirees—they're becoming very much unaffordable, like Orlando and Tampa and some other markets on the western coast [of Florida]. What all of those markets have in common is more relative affordability than where people are moving from. So compared to New York, Atlanta—or Orlando or Nashville—still seems affordable. They can come in, they have a lot of cash and are able to buy a home. But if you live in those markets, you're seeing your buying capacity shrink because you're not seeing income growth to match the level of home price appreciation.

Heintjes: I see. Well, you mentioned Nashville. Let's talk about the Southeast more specifically. In terms of affordability, how does the Southeast stand versus the US—or is it not a "one size fits all" sort of question?

Purviance: Broadly speaking, the Southeast is more affordable—mostly because, you take a market like Atlanta. Atlanta doesn't have any major geographic barriers. You can sort of build out. That's not true of a market like Miami, or like Naples in south Florida. But generally speaking, because it's cheaper to build—there are less regulations, typically, in some of our markets—there tends to be more available land, and it's a little bit cheaper.

Now, that advantage is shrinking. The cost of labor and materials, particularly lumber, has increased significantly over the past several years. So that advantage—that affordability advantage in the Southeast—is shrinking. No matter how expensive it becomes here, we still have an affordability advantage over other, more established markets, like New York and New Jersey, where it's just very expensive.

Heintjes: And I would assume those other markets are also encountering the same lumber prices, and all those price pressures that we have in the Southeast?

Purviance: Yes, but most new home construction occurs in the Sun Belt anyway, so everywhere from Arizona to Texas to Florida and Georgia—60 to 70 percent of new home construction occurs in those markets. In the older, more established markets there is some new home construction, but not as much. New home construction in our region, in our district, is more affected by higher prices just simply because there is just more activity.

Heintjes: Sure, and on that note, we'll close this discussion of the Home Ownership Affordability Monitor. Domonic, I want to thank you very much for talking with us today, and I hope you'll come back soon to discuss trends in housing affordability as you continue to tweak and feed the index.

Purviance: Sure—thank you, it's been a pleasure.

Heintjes: Before we leave, I want to note that we'll have a link to the Home Ownership Affordability Monitor that we've been discussing today. I encourage you to look at it, as it's very interesting and it delves into matters that we hear a lot about these days and that we've been discussing here. And I wanted to take a moment to mention the Atlanta Fed's Banking Outlook Conference, which will be held next month. The keynote speaker will be Ali Wolf, chief economist at Zonda, and she'll discuss the housing market and so will touch on many things that we've discussed here today. If you'd like an invitation to virtually attend the conference, please send an email to supervision@atl.frb.org.

And that's all for this episode of the Economy Matters podcast. I'm Tom Heintjes, managing editor of the Atlanta Fed's Economy Matters magazine. I hope you'll subscribe to the podcast to hear future episodes as they come out, and I also hope you'll check out Economy Matters on our website at frbatlanta.org. Thanks for being with us today. Please come back next month, and happy 2022!