Heated market conditions and a shortage of homes for sale continued to put upward pressure on home prices in California, driving the state’s median price above the $800,000 benchmark for the first time ever in April, as home sales soared from last year’s pandemic-level lows.
Housing continues to soar upwards with seemingly no end in sight, affordability weakens, yet homes are still not too far out of reach for most buyers because of low mortgage rates. I read an article recently that helped put value in check. in 1980 , a new car cost around $7,200 and a gallon of gas was $1.19. It was $2.25 for a movie ticket, 15 cents for a first-class stamp, 91 cents for a dozen eggs, and $2.16 for a gallon of milk. If only we could pay those prices now! But household income was very different back then, the Orange County median household income in 1980 was $22,000, a drop in the bucket compared to today’s $100,000 level.
This article highlighted perspective. Looking only at housing prices tells only part of the story. It is important to also consider household incomes and the prevailing mortgage rates. Naysayers are quick to point out how the median sales price was much lower back in prior years; however, taking into consideration both the median income and the average 30-year mortgage rate illustrates how buyers can afford so much more today. The historically low mortgage rate environment has stoked today’s insatiable demand and has allowed housing to soar over the past year.
To understand where this heightened demand and buyer’s exuberance is coming from it is necessary to consider where interest rates and income have historically been and their impact on affordability. The chart below highlights how higher interest rates limit the price of a home that a buyer can afford. In 1980, the average mortgage rate was 13.75%, the median income was $22,000, and the median detached sales price was $108,000. That meant that the monthly housing payment was 55% of a homeowner’s income. Rates continued to drop and incomes climbed decade after decade. In 2000, mortgage rates were at 8%, the median income grew to $56,000, and the median detached sales price had blossomed to $317,000. Yet, the monthly payment was only 40% of a homeowner’s income. It swelled to 59% in 2007, just prior to the start of the Great Recession, and dropped to 33% in 2012 as housing began to climb once again. Flash forward to today’s 3% mortgage rate, $101,000 median income, and a record setting April median detached sales price of $1,100,000, and the monthly housing payment is 44% of a homeowner’s monthly paycheck.
Mortgage rates reached 17 record lows since the start of the COVID-19 pandemic, which dropped the monthly payment substantially. That meant that a much smaller slice of a homeowner’s monthly paycheck went to paying the mortgage payment. It dropped to 37% last year, prompting buyer demand to escalate. As a result, prices surged and incomes have not kept up; thus, affordability eroded and now stands at 44%. But it has climbed to much higher levels in the past. In perspective, today’s level is not yet concerning.
It is important to note that when interest rates do rise down the road, that it will impact affordability considerably. At today’s $1,100,000 median detached sales price and $101,000 household income, a 3.5% rate would result in a monthly payment that would be 47% of a homeowner’s income. At 3.75% it would rise to 49%. Today’s historically low mortgage rates have led to a heightened sensitivity to smaller rises in mortgage rates. As rates rise in the future, the housing market will most certainly downshift.
Based upon the number of homes available to purchase today and current, red-hot buyer demand, the Expected Market Time (the time between hammering in the FOR-SALE sign and opening escrow), a snapshot of the speed of the local housing market, has remained at the ultra-low level of 22 days, a scorching Hot Seller’s Market. It is technically a “Hot Seller’s Market” when the market time falls below 60 days. Today’s 22-day level is far below that threshold, indicative of a market with rapid price appreciation, multiple offers, and an auction like atmosphere that results in most homes selling above their asking prices. The current market time levels reveal that there is still room for home values to climb in spite of the erosion in home affordability.
Credit to Steven Thomas – Quantitative Economics and Decision Sciences.