Home affordability has plummeted
Today’s housing market is less affordable than at any time since 1984. Monthly principal and interest payments are up 94% in just the last two years, according to Intercontinental Exchange, and a typical household would have to spend 41% of their income to make their monthly mortgages payments, up from an average of 25% over the last 35 years.
Higher mortgage rates, while clearly a problem, are not the only problem. In the 1980s, when affordability last reached similar lows, the average home price was around 3.5 times the median household income. Today that figure is closer to six times the median household income. Simply put, incomes have not kept pace with the steady rise in home prices since the GFC and certainly not since the surge in prices after COVID-19.
However, it is perfectly reasonable for home prices to have outpaced income when financing costs were falling. Surging prices simply brought the market back to an equilibrium—with mortgage costs low, families could afford to pay higher prices. But when those higher prices meet a nearly 40-year high in mortgage rates, affordability collapses and something has to give.
There are not enough homes in America
Part of the problem has been just a matter of space: Whether a simple shortage of available land and/or increased restrictions on using that land for environmental preservation, finding places to profitably build new homes has become more difficult in recent decades.
But the larger problem has been a dramatic reduction in the number of new homes built after the GFC. While it is understandable that both builders and consumers would want to take a step back from investing in housing, for almost a decade the completion of single-family homes was almost half its long-term average. And while new construction has steadily risen from the lows in 2011, it has only recently risen above its long-term averages. It will take time for the country to generate enough supply to make up for the lost decade in home construction.
Meanwhile, the U.S. has been relatively unique in the developed world in seeing steady population growth, both from domestic births and immigration. Furthermore, demand for housing is growing more acute as the millennial generation enters home-buying age. And, Americans have been migrating, from the rust belt to the sun belt, from the cold of New England to the warmth of Florida. While migration itself does not mathematically cause a net shortage of homes, in practice it does. Migration can result in large swaths of existing homes being abandoned or nearly worthless as communities are drained (remember those stories about homes for $1 in Detroit?) and an acute shortage in the warmer/sunnier areas where people want to live. For cities in these areas growing rapidly, new construction is required, returning us to the problem of available space.
More recently, COVID-19 changed the demand side of the equation for many families. Working from home meant less burdensome commutes, making suburban or even rural living more palpable. And, working from home, together with (for a while at least) educating your kids at home, fueled a demand for more living space. The result was a rise in the perceived value of owning a home, at a time when the availability of single-family homes was in short supply.
Finally, an increasing percentage of America’s homes have been bought for use as second homes or for investment purposes. A recent study by the National Association of Realtors estimated that 13% of the entire stock of American homes are owned by institutions or investment vehicles looking for rental income. According to nonprofit news outlet Stateline, nearly 25% of all single-family homes sold in 2021 were bought by investors, up from 15-16% annually since 2012.
Bottom line, America has a housing shortage, with the absolute number of homes available to purchase at a nearly 25-year low, as shown in the Figure below. The U.S. housing agency Freddie Mac estimated back in 2020 that the country was short about 3.8 million housing units, or a little more than 1% of the entire U.S. population. While that number has stabilized since then, a substantial shortage is likely to remain for some time.