Home Affordability Returns to Pre-Bubble Levels

Posted by Emily Ray-Porter Group on Tuesday, February 8th, 2011 at 2:56pm.


Home affordability has returned to pre-housing-bubble levels in a growing number of U.S. markets over the past year, buoyed by several years of sustained price declines, according to data from Moody's Analytics.

The data track the ratio of median home prices to annual household incomes in 74 housing markets. By that measure, housing affordability at the end of September had returned to or fallen below the average reached between 1989-2003 in 47 of those markets. Most economists believe the housing boom began in 2003.

During the housing boom, lax lending and speculation pushed house-price inflation far beyond the modest rise in household income. Nationally, the ratio of home prices to annual household income reached a peak of 2.3 in late 2005. But by last September, it had fallen to 1.6, well below the historical average of 1.9 between 1989 and 2003.

"Based on incomes, this is as affordable as it gets," said Mark Zandi, chief economist at Moody's Analytics. "If you can get a loan, these are pretty good times to buy."

But the bad news is that those price declines are leaving more borrowers underwater or in homes worth less than the amount owed.

Most economists and housing analysts anticipate another 5% to 10% decline in prices before they reach bottom later this year or early next year. Housing demand remains weak because buyers are skittish about the economy and lending standards are tight.

Markets that now appear to be undervalued include Detroit, Las Vegas, Atlanta, and Phoenix. Even in such markets, high rates of foreclosure and underwater borrowers should keep downward pressure on prices. "They're undervalued, but they're going to get even more undervalued," said Mr. Zandi.

Measuring home prices to income is not the only way economists measure housing affordability. They also examine the relationship between house prices and rents. By the price -to-rent ratio, or the price of a typical home divided by the annual cost of renting that home, prices are fairly valued—or undervalued—in around 20 markets. Nationally, the price-to-rent ratio stood at 14.85 at the end of September, above the 1989-2003 average of 12. The data suggests pockets of the country have further to fall.

Home prices still remain overvalued by both measures in several markets, including Seattle, Charlotte, New York and Portland, Ore.

Based on rents, "it's still not a slam dunk to buy" in those markets, said Mr. Zandi. He said housing markets appear to be most overvalued in the Pacific Northwest, a region that was among the last to enter the housing downturn. Historical measures also show prices are still high along the Northeast corridor from Baltimore to Boston.

The cost of owning a home looks less affordable based on rents than it does on incomes, in part, because rents also fell throughout 2009 and the first half of 2010. As rents rise, that could tip the scale back in favor of owning in some areas.

Of the 74 markets, Baltimore appears to be the most overvalued housing market. By contrast, prices in Cleveland, the most undervalued market, have returned to 1991 levels based on the price-to-rent ratio.

Historical measures comparing rents and incomes to home prices provide a useful gauge of affordability, but they can be imperfect at measuring how close different markets are to recovering from a bubble. After a severe housing downturn, home prices rarely stop falling once they reach equilibrium level.

Some areas will stay undervalued for years as they deal with a glut of foreclosures and a paucity of demand. Historical trends show that housing could remain undervalued in many markets for six to seven years, according to housing economists at Capital Economics.

"It's become cheaper to buy than to rent" in Phoenix, said Jon Mirmelli, a real-estate investor in Scottsdale, Ariz., who is renting out foreclosed homes. "But the question is: can you qualify for a loan?"

At the same time, some areas that appear to be overvalued relative to historic norms, such as Washington, D.C., may not completely return to pre-crisis levels thanks to structural changes in the economy that support higher prices.


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