As my avid readers know, I eagerly await the ever important California Housing Affordability Index number released from the California Association of Realtors (C.A.R.) each quarter.
I hope after following these quarterly affordability blogs that you are as excited as I am to see the latest numbers.
For those of you that do not know, the Housing Affordability Index number has been one of the most accurate forecasting data points of the California home market’s. It has been a fabulous early indicator for booms and busts in the home market thanks to its measurement of how many buyers can afford homes in our great state.
The more people that can afford homes, generally the more runway the housing market has to grow higher in price.
The fewer people that can afford homes, generally predicts that price appreciation may be running out of steam.
For a healthy market, we really want to see balanced affordability.
Before I get to the new Q3 2023 Housing Affordability Index number, which continues to get uglier, I want to share my boilerplate summary in the next section for those not up to speed or for those who are reading the blog for the first time.
Understanding the C.A.R. Affordability Index
To preface, this section below is a copy/paste from my previous blogs.
C.A.R.’s Housing Affordability Index is an important metric as it aims to figure out how many statewide households can afford the typical home in California.
The index considers the current median-price of existing homes in California, and assuming a buyer has 20% down, it calculates the overhead (mortgage, taxes, and insurance) to own that home along with how many California residents can afford that home based on income data.
So, a Housing Affordability Index number of 50 means 50% of the population can afford the median-priced home under current conditions.
A Housing Affordability Index number of 35 would mean 35% of the population can afford a home, a number of 64 would mean 64% of the population, and so on and so forth.
What history has shown is when more residents that can afford a home, the more home prices can move higher. Conversely, the fewer the residents that can afford homes in the state, that can indicate times of plateau and even a pullback in prices.
For example, past California housing corrections have occurred right around 17% affordability. Right before the Great Recession in 2005, affordability hit 17% (like other CA peaks) and dropped to as low as 11% in 2007 (the lowest number ever) thanks to liar loans that fueled a real estate bubble.
On the flip side, in 2010-2012 when the CA market bottomed, affordability in the state averaged 50% and went as high as 56% affordability. Looking back 10 years, that proved to be a time with the greatest upside. And, the Housing Affordability Index number gave clues to the future.
In a nutshell, history within the C.A.R.’s Housing Affordability Index has suggested:
• Buy confidently when the index hits in the 30s (buy with both hands in the 40s & 50s)
• Sell when the index hits the high teens (bubbles occur in the low teens)
For the past nine years, the index has been range-bound between 23 and 36.
A little over two years ago, I wrote a blog post about the Housing Affordability Index “Might Be Flashing Warning Signs” when the index hit 23 in the second quarter of 2021.
Worst Affordability Since the Great Recession
Now that you know how the Housing Affordability Index number tracks the California housing market, let’s finally get to the most recent Q3 numbers from the California Association of Realtors.
*I want to note that I changed the 2023 Q1 number and 2022 Q2 number as C.A.R. looks to have revised those number in their historical Excel sheet (both were moved by one percentage point).
• 2021 Q1 – 27%
• 2021 Q2 – 23% (my “might be flashing red” blog)
• 2021 Q3 – 24%
• 2021 Q4 – 25%
• 2022 Q1 – 24%
• 2022 Q2 – 17% (warning is officially here)
• 2022 Q3 – 18% (concerning, if this doesn’t rise)
• 2022 Q4 – 17% (historically not sustainable)
• 2023 Q1 – 19%
• 2023 Q2 – 16%
• 2023 Q3 – 15%
I have now covered the Housing Affordability Index number over the past 11 quarters, and you can see how the list above shows the march down to terrible affordability throughout the state of California.
My “flashing red” blog gave a year in advance heads-up on the potential affordability crisis, and it now seems that the challenging affordability continues to only get worse.
The latest number released at 15% could not be more concerning.
Let me give you some perspective on why the current number is such a concern…
The last time the affordability number was lower than 15% was back in Q3 of 2007 when the index hit 11% – the absolute peak of the market before the 2007 housing bubble burst and sent the entire U.S. economy into what is now known as the Great Recession.
All other California real estate recessions occurred when the Housing Affordability Index number reached the high teens (think around 17%), and we are now below those historical numbers.
Now I am not a doomsdayer, but the current affordability index number is quite scary when compared to history.
Let’s break down the Housing Affordability Index number even further.
Breaking Down the Numbers
There are three main take-a-ways from the latest Housing Affordability Index report.
1. Median priced homes increased by just 2.2% compared to Q3 of 2022
2. The minimum yearly income to afford a home grew to $221,200
3. Monthly payments are now at $5,530/mo with a 7.14% 30-year mortgage
Firstly, while statewide median home prices increased, they only climbed a minuscule 2.2%, which is hardly an increase compared to current inflation.
Despite the muted price growth, housing affordability still deteriorated.
The effective composite interest rate used to calculate the Housing Affordability Index number was the likely culprit of worsening affordability as it reached 7.14% for this Q3 report. Unfortunately, home mortgage rates are still higher today, creating a continued headwind for affordability and the California home market.
The minimum yearly income required to buy a median priced home climbed by a little over $13,000 to $221,200. Last quarter, the required minimum yearly income also increased by $10,000. These increases are just too much for most worker’s yearly incomes to keep pace with rising home costs.
Lastly, monthly payments at $5,530/mo are now 292% higher than they were at the affordability peak in Q1 of 2012 when just $1,410/mo was needed to afford a median priced home. Simply incredible.
More interesting facts from the report:
• Los Angeles County is still less affordable than all of the Bay Area
• Nationally, U.S affordability sits at 34%, lower both sequentially and year-over-year
• Orange County affordability is now at 11%, equaling Los Angeles County
And, while the national United States housing affordability is low at 34%, it is still not close to its most unaffordable, when the entire country got to 11% affordability before the bubble burst in 2007. But obviously, California and our local counties are matching those horrendous numbers prior to the start of the Great Recession.
The fact that only 15% of Californians can afford the median-priced home is concerning.
What’s more, an 11% affordability number in Los Angeles and Orange County is not a recipe for a steady and sustainable housing market.
As mentioned in last quarter’s Housing Affordability Index blog post, I am not a Cassandra (doomster) when it comes to this number, even though history suggests a housing recession in the state is highly likely.
There are market dynamics keeping this housing market on solid footing:
1. Historically low supply creating an inventory squeeze
2. Homeowners with loads of equity and rock-bottom mortgage rates
3. Essentially, no forced sellers to be seen
As a result, I believe this housing market can tolerate this low affordability for longer.
As pure opinion, this market might be able to tolerate lack of affordability for another six to 18 months. After that, it is anyone’s guess.
But with Tuesday’s CPI number showing inflation might be cracking and financial pundits predicting that The Fed might cut rates in 2024, then that will help to bail out this market and bring affordability higher.
Either prices need to come down significantly or mortgage rates need to come down.
If I had to bet, I am betting mortgage rates will come down to ease the affordability crisis that rarely ends well.
If not, eventually prices will have to crack, but my belief is that there is still time.
I am looking forward to the next Housing Affordability Index update in February. See you next week.