Maintenance workers in front of a housing development sign near new homes in Fairfax, Virginia on August 22, 2023.

Andrew Caballero-Reynolds | AFP | Getty Images

Buying a home is becoming increasingly difficult.

The National Association of Realtors said earlier this month that its housing affordability index fell to its lowest level on record in the second quarter. The reading was 92.7 compared to 101.8 in the first quarter. It is also well below the 180.4 reached in 2021.

A score of 100 signals that families with the median income have the money to buy a house at the median price. The reading below suggests that the average family income is not enough to buy a home. The data goes back to 1986.

Incredibly, housing is less affordable today than it was before the Great Financial Crisis – when a complete collapse in lending standards led to a speculative frenzy that ended in a 33% peak-to-trough fall in house prices (according to S&P). Case-Shiller 20 City Home Price Index) from July 2006 to April 2009.

Should that make us nervous?

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The decline in housing affordability appears to have been heavily influenced by the huge rise in mortgage rates, currently around 7.2% according to data from Freddie Mac. This compares to an average of 4% from the end of the Great Recession in 2009 to the end of 2021.

In fact, current mortgage rates are nearly three times what they were in late 2020 and early 2021 — when they bottomed out at around 2.7%. Not coincidentally, the first quarter of 2021 turned out to be the peak of housing affordability.

Since then, property prices have risen by 28% despite the massive rate hike. Median household income, which is currently growing at around the pre-Corona rate, has not been growing nearly fast enough to offset the rise in mortgage rates and the rise in house prices. The result has been a massive drop in housing affordability to new lows.

I know all the arguments.

A Wednesday Wall Street Journal article entitled “How High Can the Housing Construction Rate Get?” by Justin Lahart read: “On Wednesday, the National Association of Realtors reported that just 980,000 existing single-family homes were for sale last month. That was the lowest number in July – usually a time of year when there are many homes on the market – on record dating back to 1982.”

Real estate prices remain high due to the extreme lack of supply. The inventory of homes for sale is very low as nobody wants to move and give up their 3% mortgage. The work-from-home trend is another factor causing homeowners to remain in place, thus suppressing the housing stock.

It will take years to reconcile housing supply with demand as not enough housing has been built since the Great Financial Crisis. Lending standards have improved dramatically since the global financial crisis.

The typical homeowner has a lot more equity than they used to. Interest rates are likely to start falling next year as it becomes clearer that inflation is on a sustainable path towards the Federal Reserve’s 2% target. And so forth.

All of this is probably true. Still, housing affordability is at its lowest since at least 1986. Many potential first-time buyers risk being locked out of the market forever if nothing changes.

Can insufficient supply alone keep house prices high despite such a sharp increase in the cost of borrowing? Is it realistic to think that all will remain in place indefinitely just to keep their mortgage rates low and thus prevent a supply glut in the market? Will political pressure on the Fed force the central bank to cut rates faster, thereby improving affordability?

These are all important questions and I don’t have all the answers. My suspicion is that a combination of a slowdown in the labor market, tighter bank lending standards, volatility in capital markets and rising mortgage rates will result in an end to the Fed’s rate hikes sooner rather than later. For as long as I can remember, the Fed has always taken the path of least pain, and I don’t think this time will be any different.

If that means the Fed will tacitly set an inflation target above 2% for a short period of time, then I think it’s likely. Ultimately, however, I continue to believe that the Fed’s rate hikes to date will be more than enough to slow the economy, bring inflation to target levels and potentially trigger a recession.

The “long and variable lag” has proved longer than expected, in no small part because homeowners wisely set extremely low mortgage rates when they had the chance. But fixed-rate mortgages will not be enough to offset the impact of a 525 basis point rate hike in a historically short period of time.

Given its importance to the broader economy, a robust real estate market is likely to be a prerequisite for a relatively seamless transition to long-term economic growth. The scarcity of housing affordability remains a risk factor that not only slows the economy’s growth potential but could also trigger a financial crisis if left unchecked. So add another ball to the Fed’s juggling act.

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