Housing affordability is hitting rock bottom, and it’s not just because of the Federal Reserve’s rapid rate hikes or the government’s excessive pandemic spending. There are many factors at play, including demographic shifts and a lack of new construction, which are making it harder for first-time buyers to get a foot on the property ladder. But this isn’t about pointing fingers. It’s about understanding the Fed’s intentions and how we, as consumers, can adapt.
Let’s take a look at some charts that show just how dire the situation is for first-time buyers. The National Association of Realtors has a Housing Affordability Index that’s currently at its lowest point since 1990. If you’re a renter or looking to buy, you’re probably hoping for lower mortgage rates and no bidding wars in 2024. But with the stock market soaring, pent-up demand, and a significant drop in mortgage rates after the Fed Chair’s speech in December 2023, bidding wars might be back on the horizon.
Other charts, like those from Bloomberg and the Atlanta Fed, paint a similar picture. The U.S. median housing payment as a percentage of median income has hit a record high of 43.8%. And the mortgage payment to income ratio has also increased, even when you factor in a 20% down payment and exclude taxes, insurance, and PMI.
The Federal Home Loan Mortgage Corp and the NAR have a chart that compares the average 30-year fixed-rate mortgage to the Housing Affordability Index since 1981. It’s clear that as mortgage rates rise, affordability drops. From 1980 to 2012, lower mortgage rates made houses more affordable. But from 2012 to 2021, rising home prices made houses less affordable. And after 2022, home prices remained high while mortgage rates more than doubled, causing a sharp drop in affordability.
So, what does the Fed want? It seems they might be aiming to create a nation of renters. Despite knowing that first-time buyers are being hit hardest by high mortgage rates and home prices, the Fed has raised the Fed Funds rate 11 times since 2022 and might raise it again in 2023. This, along with a sharp rise in the 10-year bond yield, is slowing down borrowing and investment.
The Fed claims it’s fighting inflation to help middle-class Americans afford to live. But their actions suggest they might be trying to increase the number of renters to support the growing investor class. By raising rates, they’re pricing out middle-class and younger Americans from buying and maintaining a home, leaving them with no choice but to rent. This growing divide could have significant socioeconomic consequences in the future.
The Fed knows that home prices have risen significantly since the pandemic began in 2020. By raising the Fed Funds rate, they’re trying to slow down home price appreciation or even cause prices to drop, making homes more affordable. But their aggressive rate hikes have created a situation where both home prices and mortgage rates are high. This discourages homeowners with low mortgage rates from selling, forcing more Americans to rent for longer.
But falling home prices aren’t necessarily a good thing. If they drop too much, recent homebuyers could be wiped out, leading to a domino effect of foreclosures and short sales that depress prices further.
The Fed has all the data and uses it to make decisions on interest rates. They know that about 66% of Americans own homes and that a growing number (~16%) own more than one property to earn rental income for retirement. By increasing the number of renters, they’re reducing the government’s burden of caring for older generations. Social Security is already underfunded by about 25%, and no politician wants to raise the retirement age or cut benefits. If retirees with rental properties can see steady increases in rent that keep up with inflation, they’ll rely less on the government, freeing up resources for those most in need.
So, why are homes still being sold when affordability is so low? Wouldn’t it be better to save money by renting? In the short term, yes. But in the long run, renting is usually more expensive because you don’t build any equity. The annual rent cost to gross income ratio has also hit a 20-year high of 40.6%. Given that renting is the alternative to owning, the cost of homeownership doesn’t look too bad.
The fact that the Federal Reserve is making homeownership increasingly out of reach for younger generations shows that they’re on the side of homeowners. We also know that the federal government favors homeowners due to generous tax benefits. So, everyone’s goal should be to own their primary residence and at least one rental property. This way, housing affordability won’t be a big issue in the future.
If mortgage rates return to their 40+-year trend, demand for real estate will increase, pushing up prices. If interest rates stay high for a while, demand for rental property will increase, pushing up rents. This is especially true if the labor market is strong. Of course, real estate prices may soften or decline when mortgage rates rise. But as long as prices don’t crash, rental property owners should come out ahead.
Long-term rental property owners care more about rent prices than property values. If you’re a retiree, your goal is to generate as much cash flow as possible to cover your living expenses. The value of your rental property portfolio doesn’t matter if you don’t plan to sell.
In 20 years, my rental properties will have served their purpose of helping fund our lifestyles. If my children can’t find jobs or can’t earn enough to make a decent living, my rental properties can provide affordable housing for them. I’ll make them pay rent, but no more than 30% of their annual income.
In 2002, I had a conversation with a sandwich shop owner who regretted not buying the building he rented. He said he would be making more money from rental income than from selling sandwiches if he had bought the building. This conversation made me fear being priced out of the housing market, so I bought a condo the week of my 26th birthday in 2003. I still own the condo today. It’s paid off and generates about $3,400 a month in net rental income. Owning the condo has given me housing security and eliminated my fear of housing affordability.
But what if housing becomes even more unaffordable? If the U.S. housing market becomes like Canada’s, where home prices are much higher relative to income, U.S. home prices could rise by another 30% to 70%. Inflation and economic growth are powerful forces, so I suggest buying real estate as young as you can to at least keep pace with inflation and economic growth. In ten years, you’ll probably be glad you bought today.
What are your thoughts on housing affordability today? Is homeownership becoming a luxury instead of a right? How will the social dynamics play out between younger generations who can’t afford homes and older generations who can? Do you think the Fed wants to create a nation of renters?
