Max and Me

Max and Me

Thursday, December 6, 2018

Affordability-what is it and how does it impact our housing market

Affordability. A lot of us talk about what we can and can't afford, but what does that look like in terms of real estate and what does it mean for our overall economy? First and foremost, I'm going to suggest that you check out my youtube channel where I discuss interest. I'll be sure to include a link below. The gist is more or less that interest rates impact how much you can afford. As each individual payment becomes more as a result of higher interest, affordability decreases because your money is going towards interest rather than principal, aka payment on loan.

This means that as the Fed continues to hit us with rate hikes, our monthly payment increases and therefore reduces how much we can afford to purchase. This rate of affordability is decreasing as the Fed continues to increase interest rates.

For nearly 6 months now, I've been predicting a market slow down as a result of the increasing pressure on affordability. Normally the counter argument is that interest rates are still historically low compared to other economic cycles in our history. That's definitely one argument, but the better argument for buyers is your reduced property tax rate. Our market is still growing, but at a reduced rate. The volume of transactions is the most significant decrease across the board especially if you're following our market. I think in our quarterly market update meeting, the volume of transactions had reduced by as much as 20%.

This scares an awful lot of people and brings up the dreaded idea of another recession. How does our current market stack up in comparison to our pre-recession market? We may not have the concept of depression era mentality, but we definitely have recession era mentality. Many reports will tell you that we have surpassed pre-recession highs. However, those reports are not adjusted for inflation. That is hands down the most muddling factor when looking at data and it's beyond important to note for the sake of comparing markets. Nominally and in Orange County in particularly, we have far surpassed pre-recession highs. However, if you adjust for inflation, we're closer to our 04-05 market. The reason I bring up this difference is that in 04-05, most people were keeping up the Jones's and not doing the math themselves in terms of what they could or could not afford. They were depending on big banks to tell them what they could afford. It was right at about this point that lending got really squirrelly. These days, the banks require more in a down payment or PMI and people are evaluating their overall financial health for themselves. Because of this, our market is responding more appropriately than it did in the past.

I don't know about everyone else, but my grandmother had depression era mentality until she died. It got significantly worse with dementia, but she did a lot of weird things. The one that stands out to me most is that according to my mom, my grandmother kept ice cream until there was fuzz on it. Not sure how long that is, but it sounds like she was trying to get some value out of her investment. I think milennials are a bit of a split. Some are very financially conservative like my grandmother. (I had an old roommate that would eat food so old that it basically made her sick). There are others that have no idea what it takes to own a home, whether they want to or not, and are more or less living paycheck to paycheck,

Why do I mention all of this crazy stuff? I do it to demonstrate that we are in the 04-05 market which was the precipice point pre-recession where people were buying properties beyond what they could afford aka sub-prime lending and/or keeping up with the Jones's. That being said, we have a significantly different climate from that period. First and foremost is that lending is far more difficult now than it was then. This keeps people from purchasing properties beyond what is in their scope of affordability. Second, people fail to forget about the great recession and many people have been very hesitant throughout this entire cycle as a result. Third, many milennials want to purchase a property and never move and never keep up with the Jones's, which slows the process of purchasing a home. The other side effect of making a single life time purchase is that it also contributes to fewer transactions overall.

What does all of this mean? Demand has slowed as buyers are being significantly more choosey. However, I think a lot of investors miss the point that they could have lower property taxes. At first, that market was very slow. There has since been movement, but it's still very slow and very reduced. This in particular somewhat baffles me as I think reducing your property taxes is one of the most valuable aspects of calculating your on-going payments because that is the one aspect of the equation that is stationary.

So what's the takeaway? Increasing interest rates has significantly slowed the real estate market as evidenced by the volume of transactions. Affordability is characterized by interest rates. If you adjust for inflation, we are at 04-05 numbers and people are responding in a responsible way that did not occur during prior to the recession and contributed to its development. This does not mean that we are in a recession as much as we are responding in a financially appropriate manner given our current market. Although it might be frustrating, most investors can benefit from reduced property taxes and might even benefit from reduced interest rates down the road. We also ought to be proud of the market overall and how it's responding in a healthy way. Although it has slowed the market, it doesn't mean things are bad. 

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