In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi discuss the economic forces influencing housing affordability trends and what that means for first-time home buyers with Economist Ksenia Potapov.

Don’t miss a single REconomy episode, subscribe today.

Listen to the REconomy Podcast™ Episode 65:

“There were only four markets that were affordable to the median renter in the first quarter of this year, meaning the median renter could afford 50% or more of the homes for sale in that market. Those were Buffalo, New York, Pittsburgh, Detroit, and Cleveland. All four are relatively smaller, cheaper markets with an older housing stock. The least affordable markets were some of the usual suspects Los Angeles, San Diego, San Francisco, San Jose, and Salt Lake City.” – Ksenia Potapov, economist at First American

Transcript:

Odeta Kushi - Hello and welcome to episode 65 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark.

Mark Fleming - Hi Odeta. And today we have got a special episode.

Odeta Kushi - That's right, we have a special episode because we have a very special guest joining us today. Joining us is Ksenia Potapov, and an economist on our team at First American. Ksenia's research focuses on demographic trends, affordability and homeownership, just to name a few. And today she's here to discuss a very important and timely topic first-time home buyer affordability. Welcome, Ksenia. It's great to have you.

Ksenia Potapov - Thanks for inviting me on. Very excited to join you both. I'm really hoping for some good 80s references.

Odeta Kushi - Please don't enable this, Ksenia.

Mark Fleming - It's too late. It's too late, I am only happy enough to oblige. But today, before we get into the 80s, we'll be giving an update on a topic we've talked about before on this podcast. But, of course, it's important to provide an update in these ever-changing times. We will be discussing our First-time Home Buyer Outlook Report. You can refer to episodes 9, 30 and 45 for more. As you can tell, homeownership is a topic that is a favorite of ours, but we will refresh your memory on the details and give an update on the most recent results. Ksenia, do you know the origins of this report?

Ksenia Potapov - I know it probably involved a whiteboard. I just imagine Mark coming across a bunch of headlines about first-time home buyer affordability and going, "No, this is the wrong way to measure it," then bursting into Odeta's office, doodling on a whiteboard, and together coming up with this new method. At least, that's how it plays out in my head.

Odeta Kushi - I can neither confirm nor deny this allegation. By the way, I just got very nostalgic about being in the office.

Mark Fleming - I'm also clearly far too predictable, I can confirm it. And I actually proudly don't deny it. There are a couple of challenges with measuring affordability. The first is that you need to account for both the demand side and the supply side of the equation. And, of course, you have to measure it for not just the average person, but everyone in the income distribution because I don't know about you, I've never met the average person. Our First-time Home Buyer Outlook report was initially inspired by something called a Gini coefficient. The Gini coefficient was developed as a measure of income or wealth inequality by the Italian statistician, Corrado Gini in 1912. It built on the work with Max Lorenz, who came up with a visual representation of inequality, what we call the Lorenz curves. In these curves, a hypothetical straight diagonal line depicts perfect equality. And another line depicts a country's actual income or wealth distribution. The further that line is from the equality line, the more unequal the distribution.

Ksenia Potapov - So, there was definitely doodling involved, wasn't there? Yeah, I can see how the Gini coefficient would be a nice solution to the problem of measuring affordability in the housing market. Affordability measures that use the median house price, for example, fail to capture the true state of the housing supply in the market.

Odeta Kushi - Right. And that's the first of two problems. The second is that many affordability measures look at income without distinguishing between renters and homeowners. And there's a pretty big gap between the incomes of those two groups. The median homeowner had nearly double the household income of the median renter in 2021, according to Census data, so that's approximately $87,000 for homeowner households and $47,000 for renter households. A potential first-time home buyer is, by definition, typically a renter and an existing homeowner, again by definition, is already able to afford a home. That is why when talking about potential first-time home buyer affordability in the following analysis, we look at renter household incomes. So, from now on, when we refer to the median renter that is synonymous with the median potential first-time home buyer.

Ksenia Potapov - Exactly. So here's how we actually apply the idea of a Gini coefficient to housing affordability. We calculate a potential first-time home buyer's house-buying power. This is how much home someone can afford, which is based on renter household incomes, the prevailing 30-year, fixed mortgage rate and the assumption that a third of that pre-tax income is used for a mortgage with a 5% down payment. Then we compare this house-buying power distribution to the distribution of homes sold in that quarter. We can put those two distributions together and answer questions, such as can the 30th percentile renter household at the lower end of the distribution afford 30% of all the homes for sale? 40%? 50%? What about the equivalent of a Jeff Bezos, or a renter at the very top of the house-buying power distribution? Can they afford 100% of the homes for sale?

Mark Fleming - Hmm. 1987. Fleetwood Mac. Dreams. Now, here I go again, I see the crystal visions of a chart with a 45-degree line running through it.

Odeta Kushi - I don't know how you just managed to work in an 80s reference after all. That's very impressive. 

Mark Fleming - Yeah, I thought so. Right. But I couldn't stop. I couldn't resist. We'll have to go back. We will add it to our podcast playlist on Spotify.

Odeta Kushi - We have to, yeah. 

Mark Fleming - Okay, back to the basics. That is the line of equality or, in our case, the renter affordability equilibrium. If you're on that line, each household in the renter house-buying power distribution can afford an equal share of homes for sale in their market. For example, a renter with house-buying power at the 30th percentile of the house-buying power distribution can afford 30% of the homes for sale in the market. Renter households above the renter affordability equilibrium line can afford more than their share of homes for sale, and those below can afford less. I would encourage our listeners to look at the latest First-time Home Buyer Outlook Report for a visual example of these curves, not my crystal visions.

Odeta Kushi - Well, now that we have this visual, we can get to our definition of an affordable market. It is a market where the median, or 50th percentile renter, can afford 50% or more of the homes for sale. If a potential buyer can afford their fair share of homes for sale, it suggests that there is enough supply at the right price to meet demand. So, using that definition, we can compare home buyer affordability through time and between markets. So let's get to the juicy details. What is happening to affordability for potential first-time home buyers, Ksenia.

Ksenia Potapov - So, in the first quarter of this year, the 30-year, fixed mortgage rate averaged approximately 6%. A year ago, it was an average of approximately 4%. That's an increase of two whole percentage points in just a year. Primarily because of this increase, national renter house-buying power declined by 22% compared with a year ago, from $302,000 to $237,000. That's a $65,000 drop. While median house prices also declined, that was not enough to offset the effect of rising mortgage rates. The result was a decline in affordability, the median renter could afford 45% of the homes for sale a year ago, but only 34% of homes in the first quarter of this year.

Odeta Kushi - Well, mortgage rates are a powerful driver of affordability. We did an analysis that looked at the trade off between mortgage rates in house prices, which found that a one percentage point decline in mortgage rates has the same impact on affordability as an 11% decline in house prices. So you'd need a lot of house price declines to compensate for the recent increase in mortgage rates, which is unlikely to happen. So affordability in the short term will largely be dictated by movements in mortgage rates.

Mark Fleming - Yes, and mortgage rates are generally uniform across the country, so their impact on affordability is felt equally across all markets.

Odeta Kushi - That's right. Mortgage rates are national. Incomes and house prices are not. The national snapshot hides a lot of variation between markets. And, as we all know, real estate is all about location. So we track the top 50 U.S. markets in our report. Can we talk a little bit about which markets were the most and least affordable?

Ksenia Potapov - So there were only four markets that were affordable to the median renter in the first quarter of this year, meaning the median renter could afford 50% or more of the homes for sale in that market. Those were Buffalo, New York, Pittsburgh, Detroit, and Cleveland. All four are relatively smaller, cheaper markets with an older housing stock. The least affordable markets were some of the usual suspects Los Angeles, San Diego, San Francisco, San Jose, and Salt Lake City. 

Odeta Kushi - Wait a minute. Salt Lake City? That is not a usual suspect.

Ksenia Potapov - That's right. Salt Lake City is a relative newcomer to this category. It was near the middle of the pack in terms of affordability back in 2020. But rapid house price appreciation over the pandemic pushed it to the bottom of the affordability list. Now, the median renter can only afford 4% of the homes for sale there.

Odeta Kushi - Wow, that is drastic. To afford the median home in Salt Lake City in the first quarter of 2023, a renter household would need a house-buying power of $711,000. Yet, the median renter in that market had an income of approximately $50,000 and house-buying power of $231,000. In the first quarter, a household would have to be in the 81st percentile of income to afford the median home in Salt Lake City. Compare that to Buffalo, where the median renter household with a house-buying power of $203,000 could afford 59% of the homes for sale. If I haven't said it yet in this episode, go Bills!

Mark Fleming - My turn to eyeroll here. Buffalo, and it's amazingly gorgeous weather and the Bills, or Salt Lake and the majestic peaks of the Wasatch Mountains and all the fun that can be had up there. Hard to explain. Wait, wait, I digress. Let's get back to business. It's hard to speculate on what the future holds, but we can trace out some potential scenarios. House price appreciation had been decelerating year over year since April of 2022. But, in February, the latest data available at the date of this recording, there was a re-acceleration. That's right. A re-acceleration of price appreciation in the monthly growth rate, according to the S&P Case-Shiller Index. It wouldn't be surprising if this one month of re-acceleration turned into a trend. The current supply of homes for sale is very limited. We're not seeing increases in inventory that normal seasonality would suggest. Existing homeowners don't want to sell in this environment because they would have to give up their sub-3% mortgage rate. New-home sales can fill some of the gap, but far from all of it. It's not enough to meet demand and that equals upward pressure on house prices and downward pressure on affordability.

Odeta Kushi - But, on the upside, now that the Federal Reserve has signaled that they might pause interest rate hikes, we may see easing in mortgage rate volatility, which would give potential home buyers some relief. It's certainly a mixed outlook for the future. But we have, nonetheless, seen that there are still some markets that remain affordable, despite the roller coaster ride the housing market has been on. Ksenia, thank you so much for joining us on The REconomy today and giving us some really great insight into the state of potential first-time home buyer affordability.

Mark Fleming - Thanks for joining us, Ksenia. I'm sure we'll be chatting again soon with more 80s music.

Ksenia Potapov - It was my pleasure. Thanks for having me on. I think I have to go and look up Fleetwood Mac now.

Mark Fleming - Yes, yes, you do.

Odeta Kushi - All right. Thank you all for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at economics@firstam.com. We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me, @MFlemingEcon for Mark and @KseniaPotapov for Ksenia. Until next time.

Thank you for listening, and we hope you enjoyed this episode of the REconomy podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2023 by First American Financial Corporation. All rights reserved.

This transcript has been edited for clarity.