OC Housing affordable relative to rent, but not relative to income
The cost of owning and the cost of renting in OC housing market is balanced. Unfortunately, neither one is affordable based on local incomes.
I once wrote that Rental parity establishes the value of residential real estate, but others use different metrics to measure value and affordability. If the metric is price-to-income, today’s prices look inflated; if the metric is payment-to-income, today’s prices look undervalued.
So which metric is correct? In my opinion, they both are.
Over the short term, it’s impossible to ignore the payment-to-income ratio because it will establish the market equilibrium at any point in time; however, over the long term, it’s hard to ignore price-to-income because interest rates will revert to the mean, so the long-term price-to-income ratio will also come back into alignment.
Since the federal reserve drove mortgage rates down to record lows to prop up house prices and bail out the banks, the short-term equilibrium is much higher than the long-term equilibrium will likely support. Therefore, one of two things are going to happen: either prices will stagnate or decline in the future to correct for this short-term distortion, or wages will go up quickly to compensate for increasing ownership costs.
If measured against inflation, either scenario produces weak financial returns, but nominal prices — the prices most people understand and focus on — will show gains, perhaps large gains if wages start to climb.
The basic problem with the housing market in California is a lack of supply. California’s housing policies devastate the lower middle class by forcing them to pay 50% or more of their income to put a roof over their head. So while housing may look affordable relative to rent, that doesn’t mean that rent is affordable.
When there isn’t enough supply to go around, both renting and owning can be far to costly relative to income. That’s the problem we have in California.
It’s clear from my monthly reports that both rent and resale prices are rising, but the current rent-own ratio still favors owning over renting. That doesn’t mean either one of them is affordable, just that one method of possessing real estate is not out of balance with the other.
Both resale prices and rents have been rising briskly, but within normal and sustainable parameters. In fact, over the last 9 months, rent has been increasing faster than the cost of ownership tipping the balance more strongly in favor of owning.
The cost of renting compared to the cost of owning is the same as it was during most of the 1990s, a period where most agree OC housing was affordable, relatively speaking of course.
As I stated previously, this doesn’t mean houses are affordable relative to income.
Study shows fewer than one in six Orange County homes are affordable to families earning the local median income
Has the price of paradise gotten too steep?
Orange County home affordability is near an eight-year low, according to an index by the National Association of Home Builders and Wells Fargo Bank.
The index shows 16.2 percent of Orange County homes sold in the third quarter were “affordable” to households making the local family median income of $85,928. The family median figure is tabulated by the U.S. Department of Housing and Urban Development.
This summer’s affordability reading was down from 18.5 percent in the second quarter and 17.4 percent a year ago.
The median house prices should be affordable by the median household income, which it is in most of the United States. The fact that houses are only affordable to the highest wage earners is due to the substitution effect.
Think about what happens in the real world. The wealthy compete with each other for the most desirable properties, generally paying cash. The highest wage earners compete for the next rung down on the property ladder because they can out-bid everyone else. Now Imagine that scenario playing out down the entire income spectrum with each level out-bidding the one below.
In Orange County, and many other Coastal enclaves, we simply run out of houses before getting down to the bottom of the income spectrum; thus the median house price reflects the wages of someone much higher up the wage scale than the median wage earner. The only way to combat this problem is to provide more housing.
The difficulty of buying a local home on a family budget helps explain why the pace of Orange County home sales slipped 3 percent during the past two years, while the local job count grew 6 percent. …
Affordability is down because home price appreciation outstrips pay raises. The median price of an Orange County home rose 6.2 percent in a year to $615,000, while local incomes rose 3 percent. …
Last year I noted that the Spring house price rally was called off due to affordability problems. Most housing analysts predicted a robust spring rally with increasing home sales and increasing prices. In the post Bold California housing market predictions for 2014, I outlined my reasoning for why it would not come to pass. The new mortgage regulations change how real estate markets work, and real estate analysts, realtors, and financial reporters failed to grasp the implications of the new changes.
When house prices go up absent an increase in wages, affordability declines. In simpler terms, if potential buyers don’t make more money, but prices go up anyway, fewer buyers can afford to buy, and those that do must substitute down to lower quality housing. This phenomenon prices out marginal buyers, and it removes the motivation to buy from others because they don’t want to accept lower quality homes. This reduces demand, which is why sales were off in 2014 and continue below 2013’s levels.
Mortgage interest rates fell back below 4% and salvaged 2015, but that trend looks to reverse next year. We have Clear proof that rising interest rates kills home sales, and rising interest rates do not boost home prices either. It looks like both sales and home price appreciation will fail to meet everyone’s expectations in 2016. Brace yourself for a slow market.
This will be a great movie!