Housing Bubble: Market Secure But Affordability Diminishing

As it does periodically, the Harvard University Joint Center for Housing Studies has issued a report that is well worth the paper it takes to print it out from where it resides on-line.

This most recent report, issued earlier this month, concerns a subject near and dear and overdone - the Housing Bubble. Harvard, however, takes a different tack; while it expects prices to remain stable, the focus is on whether home ownership can continue to be even moderately affordable for middle and low income Americans.

The housing sector, the report states, continues to benefit from the growth in numbers of households, expected to reach 14.6 million in ten years compared to 12.6 million over the last ten; expanding job opportunities, recovery of the previously depressed rental housing market and strong home price appreciation, all of which will moderate any slowdown in the market.

However, over the longer term the economy is expected to generate many low-wage jobs and land use restrictions will continue to drive up housing costs; therefore today's widespread affordability problems will also intensify.

Nationally, the report states, monthly mortgage costs for a median-priced home were stable up until about two years ago but affordability in the nation's hottest housing markets have been "eroding for some time" and the record low interest rates in the early part of the decade did not offset the wild price increases in these areas. Now the issue of affordability is becoming more wide-spread and median house prices in an increasing number of metropolitan areas is exceeding median household incomes "by a factor of four or more."

Would-be homeowners, far from being dissuaded by high prices, scrambled to enter even the hottest housing markets last year. In order to afford ever more expensive homes the buyers increasingly turned to riskier mortgage products to achieve monthly payments that were at least initially affordable.

In two years the interest only loans went from "relative obscurity to an estimated 20 percent of the dollar value of all loans and 37 percent of adjustable rate loans originated in 2005." The payment option loans which allow borrowers to choose from several different payment configurations - fully amortizing, interest only or payments which do not even cover the interest on the loan (rolling the balance into the principal) - on a month by month basis made up close to 10 percent of 2005 mortgage loans.

While the study maintains that interest only and option loans will become problematic a few years down the road when principal payments come due, borrowers have bought time for their incomes to catch up, interest rates to reverse their recent increases, or to refinance their loans or sell their homes. Thus these loans may not be a problem because, citing figures we have not seen elsewhere, the report states that most homeowners have "sizeable equity stakes to protect them from selling at a loss even if they find themselves unable to make their mortgage payments." Using 2004 figures (and we know what 2005 did for housing prices) the study states that only three percent of homeowners had equity under five percent and fully 87 percent had a cushion of 20 percent or more. The implicit caveat, however, is that any drastic decline in house values will let the wolf at the door blow the house down.

But Harvard does not see this happening. Historically sharp declines of five percent or more "seldom occur in the absence of severe overbuilding, dramatic employment losses, or a combination of the two." That these conditions did not exist, it says, is the reason that the housing boom survived the recession that started in 2001.

"With building levels still in check and the economy expanding, large house price declines appear unlikely for now." However, should the economy falter, an end to job growth could create a situation in which mortgage default rates would increase especially among those who gambled on the riskier mortgage types and housing could change "from an engine of economic growth to a drag."

The report actually calls the long-term outlook for housing "bright." The study, as stated above, cites immigration as a major contributor to the growth of households by 2.0 million more than the 12.6 million growth of the past decade with the majority of these households being minority, expanding from a 28 percent share of households in 2005 to over 32 percent in 2015.

"On the strength of this (household) growth alone," the report states, "housing production should set new records." And, as each generation has tended to improve upon the income and wealth of the generation that came before it, expenditures on home building and remodeling should at least keep its current pace.

But then comes the scary stuff. The study warns that incomes at the top are increasing much faster than those at the bottom and in the middle. If this continues, it is the luxury sector of the housing market that will benefit while affordability will increasingly become an issue for households with low and moderate incomes.

While the vast majority of households still pay a manageable share of their income for housing, affordability problems are worsening. In the booming market from 2001 to 2003, the number of households that paid more than 50 percent of their income for shelter went up 1.9 million to a total of 15.6 million households with "severe cost burdens." Remember that now we are not talking about the cost of owning a home, we are talking about having a home.

As growing numbers of families shoulder "severe cost burdens" to keep a roof over their heads, they have less and less left over for other basic needs. This has led, the study said, to an increasing trade-off between housing costs and transportation costs as people move further and further away from employment centers. And perhaps that chicken is about to come home to roost.

The government on all levels has tried to increase affordability by providing subsidies to about one-quarter of renter households and issuing tax exempt bonds and tax credits to builders which have financed nearly two million low income housing units and assisted the same number of first time homebuyers over the past 15 years, and using other methods to create affordable housing and increasing opportunities to first time homebuyers.

At the same time, the report sites restrictive land-use regulations on the local level as a deterrent to developers seeking to build affordable housing and, while relaxing such regulations will not solve the problems, "Affordable rental housing is disappearing at an alarming rate. Between 1993 and 2003, the supply of rental units affordable to those earning $16,000 or less shrank by 13 percent." (An editorial aside: a person working full time at the Federal minimum wage earns $10,712 per year.) "These dramatic losses increased the shortfall in units available to these low-income household to 5.4 million."

The report concludes with the statement that "making significant headway (to stop eroding affordability) will be difficult without the combined efforts of all levels of government to expand housing subsidies, create incentives for the private sector to build affordable housing, institute land use policies that reduce the barriers to development, and educate the public about the importance of affordable housing."

The report's bottom line seems to be that, absent a dramatic economic turndown, those who were able to buy into the housing market even recently have an investment that is safe and is perhaps even safer for those who are invested in luxury or second homes. For those who are on the economic fringes, however, the picture may not be so rosy unless dramatic changes are made on the government level.

Visit here to download this Housing Report.