The Housing Affordability Problem That Is Creating A Nation Of Renters

Housing affordability is at or near an all-time low and the Fed is partly to blame due to its aggressive rate hikes in such a short time frame. The Federal government is also partly to blame due to excess stimulus spending during the pandemic.

However, this is not a post about who is to blame for low housing affordability. There are plenty of factors that has made homeownership out of reach for many first-time homebuyers. What’s done is done. Instead, this is a post about trying to understand what the Fed ultimately wants and how consumers can benefit accordingly.

First, let’s look at some housing affordability charts to see how bad things have gotten, particularly for first-time buyers.

Charts Explaining The Housing Affordability Problem

The first chart is from the National Association Of Realtors, which shows the Housing Affordability Index since 1990. As of July 2023, the Housing Affordability Index is at an all-time low.

historical housing affordability index by the National Association of Realtors

The next chart, created by Bloomberg, shows the Housing Affordability Index in a different way. It looks much more dramatic, which many people love to see.

historical housing affordability index by the National Association of Realtors

The next chart from the Atlanta Fed shows the U.S. median housing payment as a percentage of median income from January 2006 to May 2023. The percentage has risen to an all-time high of 43.8%.

US median housing payment as a percentage of median income

The next chart shows the mortgage payment to income ratio between 2000 – 2023. The percentages are lower due to putting down 20% and excluding taxes, insurance, and PMI. If you put less than 20% down, you have to pay PMI.

If you follow my 30/30/3 home buying rule, you should limit the percentage to 30%. But I’m only including the mortgage. So this chart’s percentages have always fit my rule.

Mortgage payment to income ratio 2000 - 2023 according to the NAR

The final chart from the Federal Home Loan Mortgage Corp and the NAR, compares the average 30-year fixed-rate mortgage to the Housing Affordability Index since 1981. The chart also highlights periods of previous recessions.

There is clearly an inverse relationship between mortgage rates and affordability. As mortgage rates go up, affordability goes down. From 1980 to 2012, a decline in the average 30-year fixed-rate mortgage made houses more affordability.

However, from 2012 through 2021, home prices surged higher, making houses less affordable. Then housing affordability declined dramatically after 2022 as home prices stayed largely elevated while mortgage rates more than doubled.

Historical 30-year fixed mortgage rate average compared to housing affordability index and historical recessions

The Fed May Want To Create A Nation Of Renters

It is clear from the data that housing affordability is low in America. Good thing roughly 66% of Americans own homes. In addition, roughly 40% of American homeowners have no mortgage. As a result, housing affordability is high for the majority of Americans no matter how high rates go.

On the other hand, first-time homebuyers are bearing the brunt of higher mortgage rates and higher home prices. Younger millennials and Gen Z are getting shut out of homeownership the most.

The Fed, in its infinite wisdom, knows this. Yet, they have raised the Fed Funds rate 11 times since 2022 and may even raise rates one more time in 2023. This is also despite the 10-year bond yield rising aggressively, thereby doing a lot of the Fed’s work to slow down borrowing and investments.

The Fed can say it wants to fight inflation so that the middle-class Americans can more comfortably afford to live. However, we should consider the idea that the Fed may actually want to increase the number of renters. Actions speak louder than moral suasion.

By raising rates aggressively, fewer middle-class Americans and younger Americans can afford to buy and continue paying for a home. Therefore, those Americans who are priced out will have no choice but to rent.

A growing division is opening up, which could have large socioeconomic consequences a generation from now.

Home Price Appreciation Since 2020

The Fed already knows home prices around the country have risen substantially since 2020, the year the pandemic began. By raising the Fed Funds rate aggressively, the idea is to slow down home price appreciation or cause home prices to decline. This way, homes become more affordable.

However, by aggressively raising interest rates, the Fed has temporarily created a scenario where both home prices and mortgage rates are high. When you have the vast majority of homeowners sitting on sub-3% mortgage rates, they are less motivated to sell. In normal downturns, home prices tend to fade slowly. As a result, more Americans are forced to rent for longer.

Below is a chart put together by Lance Lambert of Fortune magazine, highlighting the housing markets with the largest price declines since the 2020 peak.

It is a GOOD thing that home prices are falling around the country. The pace of price appreciation growth was unhealthy.

With not enough supply and rock-bottom mortgage rates, bidding wars were common. Plenty of folks paid more than they could comfortably afford for a home or constantly missed out on their dream homes. This is both financially dangerous and emotionally frustrating.

However, if home prices decline too much, such as greater than 10% a year for three years, many recent homebuyers will get wiped out. In turn, this could cause a cascading effect on the nation’s housing market as foreclosures and short sales suppress prices.

A Symbiotic Relationship Between Homeowners And Renters

The Fed sees all the data, analyzes the data, and then makes its decision on interest rates. Making sure the economy doesn’t get too hot or too cold is a tough job with plenty of errors.

The Fed knows that ~66% of Americans own homes. And with a growing percentage of Americans owning more than one property (~16%) to earn rental income for retirement, the Fed also knows it needs to boost the number of renters to keep rents up.

Increasing the supply of renters helps REDUCE the federal government’s burden of taking care of our oldest generations. Social Security is already underfunded by ~25% and no politician is willing to raise the full retirement age or cut benefits. Meanwhile, Medicare and other government benefits are also costly to run.

If a retiree with rental properties can see steady increases in rent that keep up with inflation, then the retiree will depend less on the federal government to survive. This frees up more government resources for the most needy.

My theory might sound far-reaching, however, since I started writing on Financial Samurai in 2009, I’ve clearly seen an increase in popularity of owning rental real estate. With lower yields and higher volatility, stocks are becoming less people as a source of retirement income and wealth.

Build Your Rental Property Portfolio

The Federal Reserve purposefully making homeownership further out of reach for younger generations is real-time evidence the Fed is on the homeowner’s side.

We already know the federal government is on the homeowner’s side due to generous tax benefits, such as the $250,000 / $500,000 tax-free profit exclusion rule.

Given we clearly understand who the Fed and the federal government favor, everyone’s goal should be to own their primary residence and own at least one rental property. This way housing affordability won’t be a big issue in the future.

Here are the steps to take:

  • Multiply your target home’s price by 20% to come up with the downpayment amount
  • Make it a goal to save that amount in a realistic time frame, e.g. 3, 5, 10 years
  • Invest your downpayment wisely
  • Focus on your career by getting paid and promoted
  • Know what you want to do for the next 10 years
  • Understand where you want to live for at least three years
  • Reduce consumption on unnecessary things and experiences until you get neutral real estate
  • Tap your parents for a bridge loan if necessary

If mortgage rates revert back to their 40+-year trend, the demand for real estate goes up, which will push up prices. If interest rates stay high for a while, the demand for rental property goes up, which will push 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 so long as prices don’t crash, the rental property owner should come out ahead.

Cash Flow Is More Important Than Property Values

Long-term rental property owners care more about rent prices than rental property prices.

If you are a retiree, your goal is to generate as much cash flow as possible to pay for your desired living expenses. How the value of your rental property portfolio changes is inconsequential if you don’t plan to sell.

If you are a homeowner without rental property, the changes in your home’s value over time are also inconsequential if you don’t plan to sell. You have to live somewhere.

To explain further why your rental property’s value is not as important as the rent generated, let me use myself as an example.

A Decline In Rental Property Value Doesn’t Affect My Lifestyle

My rental properties have likely declined in value by as much as 10% since 1H 2022. Psychologically, this is disappointing. However, my hold duration target is until 2043, when my kids are 23 and 26.

Over the next 20 years, it doesn’t matter how much or how little my rental properties appreciate or depreciate in value. My #1 goal is to have good tenants pay as close to market rate as possible. I rely on my rental income to pay for more than half of my family’s living expenses.

If the rental properties appreciate in value, literally nothing in our lives changes. Their values are largely fixed in my net worth tracker. For retirees or jobless folks, cash flow is more important than net worth.

Although my rental properties have decreased in value, a couple properties’ 2023 rents have increased by 2.5% and 4.7%, respectively. A combined $500 increase in cash flow serves a greater purpose than any increase or decrease in property values.

I’m not borrowing against the properties. In fact, it would be best if most homeowners had properties worth less to pay less in property taxes.

Helping Maintain Our Lifestyle And Maybe The Next Generation

In 20 years, my rental properties will have served its purpose of helping fund our lifestyles. Our main goal is to have as much optionality as possible given life is so short. If we want freedom, then we’ll have it. If we find a new existing job, then we’ll try it out for a bit, etc.

After 20 years, my rental properties will be used to provide career insurance for my children through property management if they can’t get regular jobs. With the world getting more competitive every year, I suspect my children will have a difficult time launching.

Alternatively, my rental properties can serve as affordable housing for my children if they can’t get jobs or can’t earn enough to make a living. I’ll make them pay rent, but at no more than 30% of their annual income.

I’m hoping both kids grow up to be independent adults who can find great jobs and afford their own homes. But just in case they can’t, my rental properties will be waiting for them.

If they can become independent adults without our help, then I may finally sell the rental properties or keep managing them until death. This is the power of optionality.

Housing Affordability Is A Long-Time Fear

In 2002, a year after I came to San Francisco, I started getting subs at an amazing deli in the Cow Hollow neighborhood. I talked to the the sandwich shop owner and asked if he owned or rented the store.

He told me, “Unfortunately I pay rent. I had an opportunity to buy the building eight years ago, but thought it cost too much at the time. If I did, I would be making far more in rental income than I do selling sandwiches! Today, I can no longer afford to buy such a building, so I will continue to make sandwiches for the rest of my life.”

That conversation struck fear in my heart that I might be priced out of the housing market too. I was 25 years old at the time and attending Berkeley part-time for my MBA. Given I knew I would live in San Francisco for at least three years, I decided to buy a condo the week of my 26th birthday in 2003.

I still own the condo today. It is paid off and generates about $3,400 a month in net rental income. It was a great investment until 2020, when COVID hit. Now it’s an underperformer since it’s a condo and not a single-family house.

However, by owning the condo, I no longer fear housing affordability. Instead, the condo has created housing affordability by generating steady rental income.

Inflation and economic growth are two variables that are too powerful to overcome. Therefore, I suggest buying real estate as young as you possibly can to at least get neutral inflation and economic growth. In ten years, I’m pretty sure you’ll likely be glad you bought today.

Reader Questions And Suggestions

What are your thoughts about 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?

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