The California Association of Realtors (C.A.R) quietly announced their latest Q2 dataset of housing affordability numbers this month and the results were a little scary.
As many readers know, I have been committed to covering C.A.R.’s Housing Affordability Index (HAI) results each quarter because of its unique calculations that help forecast where California home prices may go.
Never before have we seen a recession brought on by a pandemic that then fueled a housing boom, thanks mostly to historically low interest rates and partly due to changing buyer needs with remote work.
Now fast forward two years, the main driver of demand – interest rates – have essentially doubled in cost. Additionally, buyers are going back to the office as companies begin to require in-person work with the pandemic in the rear-view mirror.
Thanks to these massive shifts in buying power and buyer’s motivations in just two short years, our local South Bay home market and statewide markets are in uncharted waters. We simply have not seen swings in interest rates and buyer demand like this, ever.
Since this quarter’s HAI number is now a significant factor to consider for our local and statewide housing markets, I want to recap why the HAI is so important for new readers before getting to the Q2 results.
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 California 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 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 – since able buyers have run out.
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 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 has been range-bound between 23 and 36.
Almost a year to this date, I wrote a blog post about how Housing Affordability Index Might Be Flashing Warning Signs when the index hit 23 in the Q2 of 2021. Today that warning sign might actually be here.
Scary Q2 Affordability Number
Now knowing the background of the Housing Affordability Index number, let’s get to the latest release form the California Association of Realtors.
- 2021 Q1 – 27%
- 2021 Q2 – 23% (my first warning blog)
- 2021 Q3 – 24%
- 2021 Q4 – 25%
- 2022 Q1 – 24%
- 2022 Q2 – 16% (warning is officially here)
You read that right – the affordability number dropped precipitously to one of its lowest levels on record and the lowest level in nearly 15 years which brings us right back to Q4 of 2007.
Breaking Down the Statistics
There are serious statistics to breakdown the marketplace and how it is affecting affordability.
- Median prices are up 8%, climbing to $883,370 in Q2 from $817,950 in Q2 of 2021.
- Effective composite interest rate grew to nearly 4%, whereas it was 3.2% last year.
- 30-year fixed rates grew to 5.7% end of Q2, where last year it was at 3%.
- Our high-net-worth clients right now are seeing ARM rates in excess of 4.25%.
- It now takes a minimum income of $199,200 to qualify vs. $150,800 last year.
- Monthly payments stand at $4,980 vs. last year where that number was around $3,900.
- Los Angeles is now less affordable than the San Francisco Bay Area.
Without question, the deterioration in affordability is due to rapidly rising interest rates eroding buying power in the home marketplace.
Further hampering affordability are median prices that have not quit going up.
While 30-year fixed mortgage rates are not close to generational highs, they have doubled in less than a year where the late 70s and early 80s saw mortgage rates double, but that process took three years to play out – not 10 months like we are seeing today.
I have so many thoughts to share that it will be difficult to write on the blog, but I will do my best.
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.
This week I will record a podcast solely on this affordability subject. I hope you will join me for further thoughts on the Richard Haynes Real Estate Show when it posts next week.