The residential real estate market is on fire. Record-low interest rates coupled with a housing shortage have created the perfect fuel for values to soar. According to the Case-Shiller Home Price Index, over the past two years, from November 2019 to November 2021, the median home price increased 30%. That rate, for many, is reminiscent of 2004 to 2006, just before the Great Recession, when housing prices increased 28% during the two-year period, then later came crashing down.
Lending standards have improved a lot since then, suggesting that today's home price growth is very different. However, there are other reasons to be concerned about another pullback: Affordability is one of those.
An affordability crisis
Housing affordability has been a well-known issue for decades now. It's estimated that there is a shortage of as many as 6.8 million homes to serve those living below the poverty line or earning less than 30% of the median local income. City and state municipalities, not-for-profit organizations, and the federal government are focusing on creating more housing for our country's lowest-income earners.
But thanks to the speed at which home prices and rental rates are growing right now, it's no longer the lowest-income earners who are being priced out of the market. Middle-income earners are starting to feel the pinch as affordability gets further and further out of reach.
Can't keep pace
According to data provided by the Economic Policy Institute, from 2007 to 2022, wages have grown well below the target rate of 3.5% per year, creating a $2.75 gap between where the target hourly wage should sit to where it actually is today. Not to mention, inflation, which hovered between 1% and 3% for the majority of that time, offsets the bulk of any wage growth. But today's inflation rate of 7% is erasing years of income growth for American workers.
Rental housing rates have increased, on average, 8.86% per year since 1980, outpacing both wage growth and inflation by a long shot. Single-family home prices have increased 102% during the past 10 years, averaging out to a 10% year-over-year (YOY) appreciation rate. It's easy to see why affordability is a concern.
To really illustrate the issue, I'll use a hypothetical housing example from my local real estate market, St. Petersburg, Florida. Let's say you earn close to the median income of $60,000. Your net pay after taxes should be around $49,000, which is just over $4,000 a month. The average rent in the area is $1,771, meaning you'd need to spend 44% of your monthly income on housing -- 14 percentage points above the recommended ratio of 30%.
Factor in other living expenses -- such as fuel, food, child care, utilities, or other debt obligations like a car payment, student loans, or credit cards -- and you can easily see how even the average-income earner becomes strapped.
Can lack of affordability really cause a crash?
Stagnant wage growth was already a concern as it relates to housing affordability, but today's inflation rate takes the issue to the next level. Things like groceries, fuel, utilities, and other services are getting more expensive -- which is bad news for the millions of Americans who may have already been struggling.
There is a tipping point. When the cost of living simply becomes so unaffordable for the average American, something will have to give. This could mean less overall spending, which restricts economic growth and hurts employment, or an increase in delinquencies, which strains the financial system and housing markets -- or both.
Ultimately, the outcome will be a repositioning of how money is spent, and that will include money spent on housing. People may be forced to move to more affordable areas, while others will be forced to sell to avoid foreclosure. This influx in homes for sale could help teeter the imbalance we are seeing today and increase the supply of homes, helping home price growth cool.
I think a housing crash of Great Recession proportions is unlikely. I do, however, believe affordability shouldn't be overlooked as a serious concern or potential catalyst for a real estate market correction.