'That Has Strong Long-Term Implications': A Conversation about the Housing Market

7/18/2024

Tom Heintjes:Hello, and welcome to a new episode of theEconomy Matters podcast. I'm Tom Heintjes, managing editor of the Atlanta Fed'sEconomy Matters magazine, and your podcast host. And today I'm sitting down with one of our regular guests, Domonic Purviance, a subject matter expert in the Atlanta Fed's Supervision and Regulation Division. We have Domonic on regularly because there's always a lot to talk about when it comes to housing and residential real estate in general, and housing and housing affordability are always the focus of a great deal of attention. So, without further ado, let me welcome you back to the guest chair. It's really good to have you back in the studio, Domonic.

Domonic Purviance: It's great to be here, Tom-my pleasure.

The Atlanta Fed's Domonic Purviance. Photo by Stephen Nowland

Heintjes:Since we last spoke, can you tell me what the general trends in housing affordability have been like? I know that home sales have slowed because of higher interest rates. How has this slowing helped affordability-or, conversely, hurt affordability?

Purviance: I think you're right that higher interest rates, in addition to higher home prices, have slowed home sales overall. But affordability really hasn't been impacted, for a variety of reasons. First of all, higher interest rates really increase the principal and interest cost, and so that's keeping affordability relatively low. At the same time, we haven't seen much adjustment in home prices-mostly because as rates have gone higher, there's a considerable amount of people who decided not to sell their homes. And so demand declined because of higher rates and higher home prices, but supplies also declined because of higher rates. And generally, people are deciding not to sell because so many people have locked in their mortgages at a very low rate, that they're disincentivized to put their house on the market. And so supply and demand have sort of kept in step with each other-demand has dropped and so has supply. So we've not seen any downward pressure on price-maybe a little bit in some markets we've seen home prices decline, or we've seen the rate of home price appreciation moderate. But nationally, we have not seen a significant downward pressure on home prices that would create greater housing affordability.

Heintjes:Before we go much further, let's drill down into affordability itself a bit. Can you remind us how "affordable" is defined, and what this means to a family making, say, a median income?

Purviance: If you take a household making the median income nationally, it's around about $80,000. We define "affordability" as that household not spending more than 30 percent of their annual income on housing costs-and housing costs, for us, include principal and interest payment, taxes, and insurance. And so if you look at affordability today, by that measure, the household making around $80,000 a year, in order to afford the median-price house, which is somewhere around $360,000 to $370,000, if you're just looking at existing home prices. That household would spend around 42 percent of their annual income on housing costs. Now, anything above 30 percent is considered unaffordable. And so as of today-and this has been the case for the past several years, since home prices and interest rates have risen since the pandemic-housing nationally has been unaffordable if you make the median income. And another way to think about it is, what income would you need to make in order to afford a median-priced house? And so today, based on where interest rates are and home prices are, a household would have to make upwards of $112,000 in order for their annual housing cost to be around 30 percent of their income. So essentially, you have to make over $100,000 in order to afford the median-price house. It doesn't mean that housing isn't available for median-income households. It just means if you're looking at the center of the market-the median-it's not affordable.

Heintjes:Well, you mentioned the PITI-principal, interest, taxes, and insurance-and we hear a lot about insurance. People talk about their insurance going up, in some cases dramatically-it's been in the news quite a bit. What role does insurance play in affordability?

Purviance: If you look at total housing costs, you have that principal and interest payment, and you have taxes, and then you have insurance. Taxes and insurance we consider the nonprincipal and interest cost, so everything outside of principal and interest is nonprincipal and interest costs; and it's taxes and insurance-including HOAs [homeowners associations], which we may talk about a little bit later-all of that is outside of principal and interest. And principal and interest can be locked, so that whatever your interest rate is at origination, if you have a 30-year fixed mortgage, your principal and interest payments are locked in at a certain rate. Insurance costs can be repriced every year, and taxes theoretically can be repriced. Those are always moving targets, even if you have your principal and interest costs fixed. And what we've seen over the past several years is insurance costs-particularly in our coastal markets, that are more prone to higher weather events, and also, particularly in Florida, an increase in litigation costs-have dramatically increased insurance premiums, sometimes quadrupled in the past several years. It's added to the burden of housing affordability. I was in Florida last week, and I was talking to a guy who was telling me that he had locked his principal and interest costs in-he's in a 3 percent mortgage. And because of the increase in his taxes and insurance over the past several years, he's actually paying more in nonprincipal and interest costs than he is in his principal and interest payments. That's the case for a lot of people who may have fixed incomes, particularly retirees in Florida. They're seeing their cost of taxes and insurance and homeowner's association fees just increasing, and it's become a significant burden.

Heintjes:I know not everyone has an HOA, but many homeowners do. What role do HOA costs play in housing costs and affordability?

Purviance: I would say our number does not track HOA cost. This is something that we keep track of outside of our Home Ownership Affordability Monitor. Markets that have a lot of condominium developments typically have a high rate of homeowner's associations to cover the exterior costs of maintaining the properties. And so what's happened recently is, a few years ago there was a condo building-Miami Beach Surfside, I think is the name of the town-that collapsed, and it precipitated an increase in regulation at the state level for condominium associations to do some delayed maintenance, to update their facilities. And how condominiums pay for any upgrades is by charging some sort of special assessments to the owners. And so, because a lot of these buildings are old and there's a lot of maintenance that hasn't been done for years, these special assessments have been pretty significant. I've heard stories of assessments ranging from $20,000 to $40,000 per owner, and these have to be paid within a year or so. And so if you are a retiree on a fixed income, this is a significant problem for you.

Heintjes:You don't have that money just sitting around.

Purviance: No. Even if you have the unit paid for, you still have to figure out how to cover that cost. And I've heard-this is all anecdotal, but we've heard stories of people just deciding to sell. They just can't afford it, especially if they have a very fixed income. So, you combine that with insurance costs and higher taxes, it's really exacerbated the affordability challenges in many of the markets in our district.

Heintjes:Well, Domonic, this is probably stating the obvious, but I assume higher mortgage rates both keep potential buyers on the sidelines, as well as making houses less affordable because people don't want to sell a house with their low mortgage rate. Right? Is that what you mean by house lock, or mortgage lock or rate lock?

Purviance: Yes, there's a lot of that. There's golden handcuffs, or rate lock-the rate lock effect is what you were referring to. So if you think about it, if you refinanced your mortgage when mortgage rates went to 3 percent, you're locked into a very, very low mortgage; and now rates are over 7 percent, there's a disincentive for you to ever sell because if you sold your home, you would have to buy another house. And theoretically, if you needed a mortgage on that new house, your rate would be more than double what your current rate is. And so these sellers are electing not to put their house on the market, and that's what's keeping inventory relatively suppressed. Now, what's interesting, most people would be surprised to know that the share of first-time home buyers in today's market is higher than you would expect. Depending on what numbers, it's larger than repeat buyers. And you wouldn't think this is an ideal market for first-time buyers-and it really isn't. But what's happening is the repeat buyers have dropped out of the market, so their share is declining. Because if you own a home now, you're just not going to sell and therefore you're not going to buy another house, and so a good portion of people buying today are new home buyers simply because they don't have an existing home to sell. So the rate that's currently available is the rate they're going to get, if they're going to buy a house.

Heintjes:They don't have that same frame of reference. You know, I'm a homeowner, and I occasionally get approached by somebody offering to buy my house, and they make an attractive offer. And I say, "Well, that's nice, but I have to live somewhere; so, thanks but no thanks."

Purviance: Exactly.

Heintjes:Through all the factors we've been discussing, how would you describe housing inventory? Has it held up, or declined, or what's the effect on housing inventory? I guess they call it months' supply?

Purviance: Yes. We use a measure called the months' supply of inventory to track the level or quantity of housing inventory. Essentially, the months' supply of inventory tells you how many months it would take to absorb the current amount of inventory in a market, given the current rate of absorption. Anything below four months' supply is considered an undersupply, meaning that it would take less than four months to absorb the current amount of inventory given the current rate of absorption. So, below four is undersupplied, above six is oversupplied. Overall, nationally, we have remained consistently undersupplied for the past several years. We just don't have enough homes on the market. During the pandemic, interest rates were very low. A lot of people were willing to sell, but there were more buyers than sellers, so the months' supply dropped considerably. Today, the months' supply is low because of the rate lock effect, as we've mentioned. When supply is low, that creates this upward pressure on home prices. Now, I will say that the months' supply level, overall, is in the shortest territory, but we have seen some markets where supply is starting to increase-particularly markets in Florida, and especially Southwest Florida, in particular, where we're seeing inventory levels increase, and that's because a lot of people are just electing to sell.

Heintjes:I don't want to get hung up on this one aspect, because there are so many we need to discuss, but I'm going to kind of throw you a curveball here. You know, basic economics tells us that when there's a demand, producers will step up to meet it because there's a financial incentive to do so. So let's say there's great demand from those seeking to become first-time homeowners. Do we not see builders racing to meet that demand on the low end of the price spectrum for first-time homebuyers? What is it that's different about housing, that means that this basic truism of economics, and supply and demand, doesn't necessarily apply?

Purviance: That's a great question. The answer is...well, to the question of whether builders are trying to supply inventory for first-time buyers, the answer is yes-but with this caveat: how do you define a first-time or entry-level buyer? By price point. So, if you look before the pandemic, maybe 40 percent of new homes that were built and sold in America were priced less than $300,000. Today, the percentage of new homes that are priced below $300,000 is less than 9 percent. And so, what's happened over the past few years is the cost to build homes has increased-everything from land, to labor, to lumber, to materials, have all increased relative to where they were prior to the pandemic, and they really haven't adjusted. So, even though there's plenty of demand for housing less than $300,000, builders don't have the capacity to produce it because of the cost. I remember a few years ago, I was speaking to a builder in Miami who was telling me how strong the entry-level market for a single-family home in Miami was, and he's going on and on. And I asked him, "Well, what does an entry-level, single-family home in Miami cost?" And he said, "Well, $500,000." So today, if you're talking to a builder, you know that the floor-the entry level-for new home construction is around $300,000. That's the cheapest that you're going to build a new home, almost anywhere. There are a few places where you can do a little bit less than $300,000, depending on how much you purchase the land for. But in general, it just costs too much to build houses today, where the new home market just can't deliver product below $300,000. If you're in the market for a product below $300,000, essentially, you're buying an existing home.

Heintjes:Or a real fixer-upper.

Purviance: Yes.

Heintjes:You talked about builders, and I want to ask you about homebuilder sentiment and what you've seen lately. I can't imagine that builders are happy with higher interest rates, but obviously, the demand for their products is still pretty strong. Are different housing price points experiencing different actions, and therefore builder sentiments are responding accordingly?

Purviance: To answer your first question: I talk to a lot of builders, and they all would prefer interest rates to be far lower than they are now. So, having high interest rates is not considered a positive for the new home industry. However, everything we've talked about so far with the shortage of existing home inventories actually benefited the new home market, because there's just not enough of what we call resale or existing home inventory available. If you're going to buy a house today, particularly if you're going to buy that entry-level product, you're more likely to buy a new house just because it's what's available. And the other thing that really benefits the new home industry is builders' capacity to offer some incentives to people buying, and one of the more popular incentives for buyers is rate buy-downs. Essentially, a builder will buy down the rate for the buyer. So if, say, the current rates are 7 percent, they may be able to get you into the mortgage-at least, some of them are permanent rate buy-downs and some of them are kind of rolled out over time-but you could get in a house for 6 percent or a 5.5 percent mortgage, based on a rate buy-down.

Heintjes:Is this a relatively new phenomenon or approach?

Purviance: No, rate buy-downs are pretty normal. For builders in a high-rate environment, it's just one of the tools in the tool belt that builders will elect to use to make housing more affordable. And it's one of the things that makes buying a new house more attractive, because builders-versus an existing homeowner who's selling their home-have the capacity to provide more incentives. And as a newer product, you don't have some of the maintenance issues you would have with an older house. And I will say, it just depends on the market. I talked to builders in a market like Atlanta and they're less likely to offer rate buy-downs, simply because demand is strong enough to not really require it. And that's not the case with all builders in Atlanta, just that I do hear, when we mention rate buy-downs, builders-at least in this market-are "sometimes we do, sometimes we don't." In other markets, like in some of the markets in Florida, it's pretty prevalent. You have to offer a rate buy-down to get people in the home. Sometimes it's just offering cash at closing that the buyer can use to have upgrades or lower the sales price, or whatever. But incentives are a necessary tool that builders are having to use to get people into homes today. And builders, I will say, felt more optimistic coming into the year than they did once rates started to increase. So the hope at the beginning of the year was that rates were going to decline, that we would see some rate cuts. That didn't materialize.

Heintjes:We'll touch on that momentarily, so hold that thought. As you just noted, the Southeast is not a monolithic market, by any means. Housing in south Florida, as you noted, is very different from housing in, say, eastern Tennessee. Do you have any observations about some of the specific markets in the Southeast and how they're performing?

Purviance: Yes, I mentioned Atlanta is one of our strongest markets. Inventory remains very low, demand remains strong, job growth remains strong. I would put Nashville in the same bucket as Atlanta, although Nashville has a little bit more affordability challenges than Atlanta has, currently. Some of the markets where we're seeing weaker conditions-southwest Florida really stands out. At the beginning of this year, we saw existing home inventory increase significantly, and that's created some...first of all, an increase in inventory is an indication of some softening of the market, that we're paying very close attention to. Some other markets, like New Orleans and some other markets along the coast, we've seen some softening. What all of those markets have in common is everything that we talked about before: higher insurance costs, issues with HOA costs-all of those things are combining to create some softening in the market. In general, the Southeast tends to be a market where people are moving to, businesses are moving to, there's strong demand. In Florida-even southwest Florida-it's not the case that people are not moving at all. It's just that we're seeing less movement than we were previously, and all of the challenges we've talked about are creating some softening.

Heintjes:I wanted to touch on the Federal Reserve's role in the complex ecosystem that is housing. Some observers were looking for a cut in interest rates by now, and that didn't happen. I think you've already touched on this, but how are builders adjusting to rates being higher for as long as they have?

Purviance: I think the go-to tool, for builders in particular, has been offering some incentives. I do think "higher for longer" rates are baked in. They're prepared for it at this point. They're adjusting the type of product that they're building-so we've seen builders building a little bit smaller product, a little bit more affordable product, just to make it accessible to buyers who are adjusting to higher rates. So they're adjusting to it, and what helps is that there just isn't enough existing inventory available, so they're able to capture a larger share of the market.

Heintjes:I don't want to end our conversation today by putting you on the spot, but I will. It's mid-June as we speak today, and I wanted to ask you to take out your crystal ball as we head into the second half of 2024. What do you foresee for residential real estate, specifically regionally in the Southeast? More of the same, or do you see changes ahead?

Purviance: Well, Tom, I forgot my crystal ball today [laughter]. What I will say is, overall, we've seen a bifurcation in our recovery. So people at the higher end of the spectrum have been fine, and people at the lower end have been more hurt by higher inflation. And one of the reasons why people have been able to continue to spend is, during the pandemic people weren't spending as much, so they saved a whole lot. And so we've seen people utilizing or leveraging the high rate of savings in order to keep spending going, even in a higher inflationary environment. Well, that's starting to starting to slow. We're seeing savings dwindle, we're seeing higher credit card utilization. We're seeing other stress in the market that indicates that, while it's not a complete slowdown, it is slowing as people adjust to higher costs relative to incomes. And so how it plays out for housing, what we're seeing is people are sort of adjusting to a higher rate reality. Rates are hovering around 7 percent, home prices are where they are. People who have to buy are buying. The same thing with sellers. People prefer not to sell with a 3 percent rate, but if they get married, get divorced, they have kids-they're going to have to buy a new house, and they'll have to sell.

Heintjes:Life goes on.

Purviance: Exactly. And so, people are beginning to adjust to the reality. The thing that people can't adjust to is, if the cost is just higher than what they make, they just can't make a "buy" decision. So you have those two factors weighing in: people have to move on with life, given where costs are. At the same time, they've dwindled down their savings, and their income growth is still positive, but it's not as strong as it was a few years ago. So, all of those things are having to adjust, and I think the result is, we'll continue to see things slow and moderate. It may not completely decline, but it will moderate in the rate of activity that we're currently seeing. In our region, my biggest concern, I think, is the higher nonprincipal and interest cost burdens that households are having to deal with, and that's insurance, we did mention taxes, HOAs-all of those are factors that we can't always account for, that may impact the market. If those people decide they can't afford and they need to sell, that may dramatically increase inventory, and that will create some downward pressure on price. That may make housing more affordable, but it also could potentially lead to a downturn in the housing market. The other "x" factor that we don't know that's out there, is what happens with weather. If we see an increase in storms this season, it could have dramatic implications for insurance costs in our district. That's something that we need to pay attention to. And the last thing I'll say is that my broader concern, outside of our immediate context, is that...it used to be the case, if you made the median income, you could afford to buy a house. You could find a house to buy, and owning a house was a critical part of your household building wealth and being able to have that safety net. And that's just not the reality today. Today, in order to own the median-price house, you have to make, as I mentioned in the very beginning, over $110,000, and that means you have to be almost 40 percent higher than the actual median income. And so you have to make more than the median income to be a homeowner today-at least, to own a median-price house. We've never experienced that before, and that has some pretty strong long-term implications that I think we just have to think about.

Heintjes:Yes. Well, I think achieving the American dream is maybe a whole separate episode for us to come back to. So, thank you for that-I won't call it a forecast, but I'll call it your very informed perspective; I really appreciate that.

Purviance: Thank you, Tom.

Heintjes:And as always, Domonic, thank you so much for taking your time to be with us today, and I look forward to having you back on later this year to talk about housing some more.

Purviance: Thank you.

Heintjes:And, before we say goodbye, I want to be sure to mention the Home Ownership Affordability Monitor, which Domonic helps oversee here at the Atlanta Fed. We'll have a link to it on our website. And that brings us to the end of another episode of theEconomy Matters podcast. I'm Tom Heintjes, managing editor of theEconomy Matters digital magazine, and I hope you'll check outEconomy Matters, as well as the Atlanta Fed's website, at atlantafed.org. Thanks for spending time with us today, and let's get together next month.

Public link

Please use the above public link if you want to share this noodl on another website.