Is 2012 housing payment affordability really much better than 2006?

House prices still seem very high in Orange County. The most recent median home price reading is $375,000, and houses sell for around $260/SF. Many potential buyers still lament the high cost of housing in Orange County, and compared to the late 1990s, house prices are much higher than inflation alone would dictate. So are house prices still too high?

Compared to the 1990s, house prices are too high, but compared to the peak of the housing bubble in 2006, prices are much, much more affordable, particularly on a monthly payment basis. Consider this, in July of 2006, mortgage interest rates were 6.76%. Today they are 3.88%. Further prices are about 30% to 40% lower. Since about two-thirds of all real estate transactions are financed, the lower interest rates make houses much more affordable. Also, since high returns are very scarce in today’s financial markets, all-cash buyers face low opportunity costs when they buy real estate. Cash buyers would prefer lower prices, but with such low returns in other investments, many cash buyers are putting their money in real estate because the cashflow returns represent an improvement over other asset classes.

Although the National Association of realtors is generally full of shit, their analysis of current affordability is correct.

Housing Affordability Index Hits Record High

Washington, March 06, 2012

Housing affordability conditions have reached the highest level since recordkeeping began in 1970, according to the National Association of Realtors®.

NAR’s Housing Affordability Index rose to a record high 206.1 in January, based on the relationship between median home price, median family income and average mortgage interest rate. The higher the index, the greater the household purchasing power.

An index of 100 is defined as the point where a median-income household has exactly enough income to qualify for the purchase of a median-priced existing single-family home, assuming a 20 percent downpayment and 25 percent of gross income devoted to mortgage principal and interest payments. For first-time buyers making small downpayments, the affordability levels are relatively lower.

Even in agreeing with the NAr, I can’t help thinking they are manipulating the numbers in a self-serving way. By my math, locally prices have just now reached rental parity. Prices are not so far below rental parity nationally that a median income provides twice as much buying power as is required to buy a median priced house. It’s in the best interest of realtors to make houses look affordable even when they aren’t. Their calculations undoubtedly error on the side of showing affordability as being better than it is.

NAR President Moe Veissi, broker-owner of Veissi & Associates Inc., in Miami, said this latest data underscores buyer opportunities in today’s market. “This is the first time the housing affordability index has broken the two hundred mark, meaning the typical family has roughly double the income needed to purchase a median-priced home,” he said. “For buyers who can qualify for a mortgage, now is a very good time to become a homeowner.”

NAR projects the affordability index for all of 2012 will be at an annual high, with little movement in mortgage interest rates or home prices during the year. “Housing inventory levels have declined to a point where conditions are becoming much more balanced in much of the country,” Veissi said. “If access to credit improves, we could see a much more meaningful increase in home sales and broader stabilization in home prices with modest gains in areas with stronger job growth.”

To illustrate how much more affordable houses are today, I have an example of a property purchased in July of 2006 that is available for sale today. The property is an REO, but it is not a short sale, so the asking price is legitimate. Further, it is not a low-end condo or a cherry-picked example of a super large discount possibly needing repairs. This property is representative of what buyers can find searching for properties in today’s market.

How much did this property cost in 2006?

23682 MARIN Way Laguna Niguel, CA 92677

$1,530,000    ……..    Asking Price

Cost of Home Ownership
$1,530,000    ……..    Asking Price
$306,000    …………    20% Down Conventional
6.76%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$1,224,000    ……..    Mortgage
$381,735    ……….    Income Requirement

$7,947    …………    Monthly Mortgage Payment
$1,326    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$383    …………    Homeowners Insurance at 0.3%
$0    …………    Private Mortgage Insurance
$206    …………    Homeowners Association Fees
$9,861    ……….    Monthly Cash Outlays

($1,949)    ……….    Tax Savings
($1,052)    ……….    Equity Hidden in Payment
$894    …………..    Lost Income to Down Payment
$211    …………..    Maintenance and Replacement Reserves
$7,967    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
$16,800    …………    Furnishing and Move In at 1% + $1,500
$16,800    …………    Closing Costs at 1% + $1,500
$12,240    …………    Interest Points
$306,000    …………    Down Payment
$351,840    ……….    Total Cash Costs
$122,100    ……….    Emergency Cash Reserves
$473,940    ……….    Total Savings Needed

Cost of ownership comparison: 2006 versus 2012

The current $999,900 asking price is 35% lower than the $1,530,000 sales price in 2006.

In 2006, the monthly cash outlays would have been $9,861 compared to the $5,086 of 2012. That’s a 48.4% reduction in monthly bills.

The adjustments to the monthly cash outlays to calculate the total cost of ownership had both pluses and minuses. In 2006, the total cost of ownership was $7,967. In 2012, this number is 56.6% lower at $4,512.

In 2006, a person reporting their true income would have needed to make $381,735 to afford this house. Today, a person making $184,844 could afford this property.

In early 2007, I predicted prices would fall 39%. I based my prediction on what it would take to make prices affordable. I didn’t count on interest rates falling from 6.76% to 3.88% — a whopping 42.6% decrease in the cost of money. Prices have fallen about 30%, and with the drop in interest rates, payment affordability has cut in half.

The fact that properties are now payment affordable doesn’t mean we are at the bottom. We still have a large overhead supply of REO, and eventually we will face rising interest rates. The low payment affordability does mean we have taken the first step toward a stable housing market.

When will the market recover?

When most people think about the market recovery, they wonder when prices will get back to the peak. That is the wrong way to look at the issue. The problem is not that prices fell from a stabilized value and need to go back up. The problem is that prices were grossly inflated and prices need to fall back to sustainable levels. If the problem is correctly defined, we see that prices have recovered. We are currently at rental parity. Some markets have overshot to the downside, and those markets will “recover” when they get back to rental parity, not when they reach the peak decades from now. So when people wonder when markets will recover, they need to accept the housing market has recovered. That’s why we had a crash.