Soaring nominal house prices dominate recent headlines and for good reason. It is true that nominal house prices are the highest they have ever been, over 22 percent higher than the housing boom peak in 2006, according to the First American Data & Analytics House Price Index. The acceleration in the pace of annual house price growth began in the summer months of 2020, as potential home buyers emerged from lockdowns armed with record low mortgage rates and were met by historically low housing supply – a perfect storm for rapid nominal house price appreciation.
“Nominal house prices increased over 13 percent on a year-over-year basis, but house-buying power has grown even faster, increasing by an amazing 19 percent year-over year.”
By conventional measures of affordability, especially in an environment of modestly rising (in some markets declining) household income, a surge in nominal house prices implies significantly reduced affordability. Yet, nominal house price fluctuations alone, or even the relationship between nominal house price growth and income growth, can be a misleading indicator of affordability, and overlooks what matters more to potential buyers – house-buying power – how much home one can buy based on changes in income and interest rates.
For example, let’s assume you earn $100,000 a year, have a 33 percent debt-to-income ratio, and put down 5 percent on a home. With a 4 percent mortgage rate, your house-buying power is $606,000. But, if rates fell to 3 percent, your house-buying power increases by $80,000. Our Real House Price Index (RHPI) adjusts nominal house prices for purchasing power by considering how income levels and interest rates influence the amount one can borrow. The ability of low or declining interest rates to boost house-buying power makes it possible for a housing market to have high or even rising nominal house prices yet remain highly affordable (as measured by the RHPI)* and vice versa. Indeed, a walk down house price memory lane shows us that nominal house prices alone are not always a good measure of affordability.
The 90s Recovery: Low House Prices, Low affordability
In the chart above, nationwide nominal house prices, real house prices, and house-buying power are all indexed to January 1990. From October 1993 through December 1994, a period when the U.S. economy was recovering from the early 1990s recession, housing was considered relatively unaffordable, even though nominal house prices were barely rising (1.0 percent). Despite relatively flat nominal house prices, the RHPI increased over 20 percent during this time period because house-buying power fell by 16 percent due to rising mortgage rates. Even though nominal house price growth was low, that was not enough to call the market “affordable” since it was accompanied by declining house-buying power and declining affordability.
The Housing Boom Era: High House Prices, Low Affordability
Nominal house prices surged in 2005 and peaked in 2006. From January 2005 through March 2006, nominal house prices jumped nearly 13 percent, while mortgage rates remained relatively steady. During this time, the RHPI also increased dramatically by nearly 15 percent, indicating significantly reduced affordability. The reason? Nominal house price appreciation far outpaced house-buying power. During the housing boom era, rising nominal house prices did signal falling affordability, but only because house-buying power did not keep up.
The Pandemic Era: High House Prices, High Affordability
In the most recent RHPI report reflecting January 2021 data, nominal house prices increased over 13 percent on a year-over-year basis, but house-buying power has grown even faster, increasing by an amazing 19 percent year over year. The result? Despite rapidly rising nominal house prices, affordability actually improved, with the RHPI falling nearly 5 percent during the same time period. In fact, while nominal house prices are now more than 22 percent above the housing boom peak in 2006, real, house-buying power-adjusted, prices are 48 percent below their 2006 housing boom peak. The lesson? In housing, you can’t judge a housing market “book” by its nominal house price “cover.” Affordability is dependent on house-buying power.
Will Rising Mortgage Rates Signal the End of an Affordable Era?
Recently, mortgages rates have increased modestly. Does this spell the end of an affordable era? Not quite. As rates rise, affordability may become an issue for some buyers on the margin. As these buyers pull back from the market and sellers adjust their expectations, house price appreciation will adjust. But, the improving economic conditions and the ongoing shortage of supply relative to demand continue to support house price growth. The underlying fundamental housing market conditions support a moderation of house price appreciation which, alongside a healthier labor market and still historically low mortgage rates, should keep housing affordable.
January 2021 Real House Price Index Highlights
The First American Real House Price Index (RHPI) showed that in January 2021:
- Real house prices increased 1.2 percent between December 2020 and January 2021.
- Real house prices declined 4.8 percent between January 2020 and January 2021.
- Consumer house-buying power, how much one can buy based on changes in income and interest rates, increased 0.4 percent between December 2020 and January 2021, and increased 18.9 percent year over year.
- Median household income has increased 6.2 percent since January 2020 and 74.8 percent since January 2000.
- Real house prices are 25.6 percent less expensive than in January 2000.
- While unadjusted house prices are now 22.2 percent above the housing boom peak in 2006, real, house-buying power-adjusted house prices remain 47.8 percent below their 2006 housing boom peak.
January 2021 Real House Price State Highlights
- The five states with the greatest year-over-year increase in the RHPI are: Wyoming (+3.4 percent), Arizona (+1.5 percent), Oklahoma (+1.1 percent), Ohio (+0.8 percent), and Alaska (+0.1 percent).
- The five states with the greatest year-over-year decrease in the RHPI are: Louisiana (-8.7 percent), California (-8.4 percent), Illinois (-7.6 percent), Massachusetts (-7.4 percent), and New York (-7.3 percent).
January 2021 Real House Price Local Market Highlights
- Among the Core Based Statistical Areas (CBSAs) tracked by First American, the five markets with the greatest year-over-year increase in the RHPI are: Kansas City, Mo. (+5.3 percent), Memphis, Tenn. (+4.3 percent), Tampa, Fla. (+3.7 percent), Cleveland (+3.5 percent), and Hartford, Conn. (+3.0 percent).
- Among the Core Based Statistical Areas (CBSAs) tracked by First American, the five markets with the greatest year-over-year decrease in the RHPI are: San Francisco (-16.8 percent), San Jose, Calif. (-13.6 percent), Miami (-11.4 percent), Boston (-11.4 percent), and Dallas (-9.1 percent).
About the First American Real House Price Index
The traditional perspective on house prices is fixated on the actual prices and the changes in those prices, which overlooks what matters to potential buyers - their purchasing power, or how much they can afford to buy. First American’s proprietary Real House Price Index (RHPI) adjusts prices for purchasing power by considering how income levels and interest rates influence the amount one can borrow.
The RHPI uses a weighted repeat-sales house price index that measures the price movements of single-family residential properties by time and across geographies, adjusted for the influence of income and interest rate changes on consumer house-buying power. The index is set to equal 100 in January 2000. Changing incomes and interest rates either increase or decrease consumer house-buying power. When incomes rise and mortgage rates fall, consumer house-buying power increases, acting as a deflator of increases in the house price level. For example, if the house price index increases by three percent, but the combination of rising incomes and falling mortgage rates increase consumer buying power over the same period by two percent, then the Real House Price index only increases by 1 percent. The Real House Price Index reflects changes in house prices, but also accounts for changes in consumer house-buying power.
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