The California Association of Realtors quietly announced their third quarter Housing Affordability Index. While affordability eased in this newly released report (California homes got more affordable), there is still cause for concern if looking at real estate purely through the affordability lens.
As many readers know, I have committed to covering C.A.R.’s Housing Affordability Index results each quarter because of its unique calculations that help forecast where California home prices may go.
Thanks to quickly growing prices and surging interest rates, California homes have seen affordability drop precipitously over the past 12 months.
While there are plenty of factors used to determine the health or general direction of the real estate market – for instance, median prices, sales, inventory, or pending sales. The HAI can help tune out the noise to simply see how many buyers are left to fuel prices higher, or conversely, when there is a stable of buyers that could step in during a market decline.
In my opinion, we now have two back-to-back quarterly numbers that are a significant factor in our housing market, so before I can get to the recent Q3 release, below I am going to explain the Housing Affordability Index further for new readers.
Understanding the C.A.R. Affordability Index
C.A.R.’s Housing Affordability Index is an important metric as it aims to figure 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 and how many CA residents can afford that home based on income data.
So, a HAI number of 50 means 50% of the population can afford the median-priced home under current conditions.
A HAI 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 the 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 can indicate times of plateau and even a pullback in prices.
For example, past California housing corrections have occurred right around 17% affordability. Preceding 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 massive real estate bubble.
On the flip side, in 2010 to 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 HAI 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 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 range has been between 23 and 36.
Just 15 months ago, I wrote a blog post about how the Housing Adorability Index might be flashing warning signs when the index hit 23 in the Q2 of 2021.
Now a year ago, we saw the 2021 Q3 affordability number tick up to 24%. Today’s Q3 number is significantly lower.
Still Concern Q3 Affordability Number
Now knowing the background of the Housing Affordability Index number, let’s finally get to the latest release form the California Association of Realtors.
- 2021 Q1 – 27%
- 2021 Q2 – 23% (my “might be flashing red” blog)
- 2021 Q3 – 24%
- 2021 Q4 – 25%
- 2022 Q1 – 24%
- 2022 Q2 – 16% (warning is officially here)
- 2022 Q3 – 18% (still concern, see below)
Not only did affordability in Q2 drop to its lowest level in nearly 15 years (to Q4 of 2007), but our latest 3rd quarter is also still holding below 20% affordability at just 18%.
Sure, the number eased a bit, but the data behind it is not any more comforting.
Breaking Down the Statistics
So the big question is why did affordability go up from last quarter when interest rates are even higher today?
The simple answer is that median prices are finally starting to cool.
In Q2’s HAI report, median prices were reported at $883,370 (up 8% from Q2-2021 at $817,950).
Today’s Q3 HAI report shows median prices at $829,760 (up 1.9% from Q3-2021 at $814,580).
So, while interest rates are higher in the Q3 report, the median price used to calculate affordability is lower than last quarter by $53,610 which is a big factor to consider. Prices are not declining, however, it is clear they are plateauing in throughout the state.
Let’s explore the statistics further:
- Median prices are $829,760, up 1.9% from $829,760 during the same time last year.
- Effective composite interest rate sits at 5.72%.
- 30-year fixed rates grew to 6.7% end of Q3, where last year it was 3.01%.
- Our high-net-worth clients right now are seeing ARM rates in excess of 5%.
- It now takes a minimum income of $192,800 to qualify vs. $148,400 last year.
- Monthly payments stand at $4,820 vs. last year where that number was around $3,710.
- Los Angeles, for two quarters in a row, is more unaffordable than San Francisco.
The rapid deterioration in affordability the past two quarters can be attributed to surging interest rates which has eroded purchasing power in the California housing market.
The small relief this month is purely due to a lower median price reading.
It looks like something has to give… interest rates or prices.
It was surprising to see affordability improve with higher rates, but obviously, it was thanks to prices being calculated at $829k in Q3, which was $54k less than Q2. Knowing that the fourth quarter will have even higher rates, we will see how long prices stay high or The Fed will keep increasing rates.
Below are my thoughts from my previous post in Q2 so you can compare. I am looking forward to updating those in 2023 when the next report comes out in February 2023.
Without question, this Housing Affordability number makes me very nervous. The accuracy with which this number has forecasted movement in our statewide home market is hard to argue.
In residential home sales, near-term home prices are sometimes dependent on “the greater fool theory.” If only a mere 16% of the population can afford the median priced home, then who is left to buy homes at higher prices?
It is a little unnerving to think about.
On the flip side, we are truly at an unprecedented crossroads in the housing market.
While California homes are now one of the most unaffordable in its history, the market is on incredibly solid footing. Let’s rattle off positive attributes in our current market:
- A vast majority of homeowners have interest rates in the low 3% range or lower.
- Home supply is still at historically low levels.
- Millennials, the largest home buying generation, will fuel home demand in the future.
- Mortgage underwriting is still extremely strict with distressed sales non-existent.
- Inflation during the late 70s and 80s saw California home surge higher.
That all said, it is hard to argue with low affordability not being a major drag on the market.
The precipitous drop in affordability is a new reality buyers and sellers need to navigate in our ever-changing real estate market. Everyone needs to strongly consider the implication and proceed with the utmost care in every real estate decision.
Next week I will be diving into this topic in more depth on my podcast – make sure to tune in!