Revisiting Affordability

The discussion around affordability keeps coming up, especially with the recent drop in housing prices and lower interest rates.  Arguments for and against real estate are often rationalized based on affordability from both bulls and bears.  But what exactly does the historic and current data show?

First let’s define affordability.  It is simply the percent of household income taken up by ownership costs.   For this exercise, I followed the methodology used by RBC (http://www.rbc.com/economics/market/pdf/house.pdf) because past information was readily available.  Household income is based on published numbers for Greater Vancouver (median) and mortgage costs are based on a five year fixed rate mortgage amortized over 25 years. You may argue that this is not representative of buyers for whatever reason, but to do so would be to miss the larger point, which is to simply compare where we are now relative to the past.

Second, let’s look at historic data.  I referenced the RBC to obtain affordability percentages (rounded to 5% increments) for various years, as follows (see page 5):

Condo       TH        SFH

1986      20%      25%      35%
1990      40%      50%      70% (Peak)
1992      30%      40%      50%
1995      35%      45%      65% (Peak)
2000      25%      35%      45%
2004      25%      35%      50%
2008      40%      50%      75% (Peak)

To define the norm, I looked to where affordability ranged for most of the time (say 80%) going back to the early 80’s. The historic norms for condominiums, townhomes and single family homes have roughly fallen between 20-30%, 30-40% and 45-55%, respectively.  These ranges ignore the ‘spikes’ of low affordability at peak years (e.g. spring 2008), but also the ‘trough’ of high affordability in the early 80’s.

And finally, where are we now?  Using $60k as the median household GVRD income (used by RBC), the latest MLS GVRD benchmark prices (Mar 2009) and the current five-year fixed rate mortgage (using the ING calculator), I come up with 27% for condominiums, 33% for townhomes and 51% for single family homes.

All of those values fall near the mid-range of historic affordability.

– Dave

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MrBear
Member
MrBear

And yet, I have no interest in buying. I wonder why that is?

arbitrage
Guest
arbitrage

hm, maybe something to do with value or renting being cheaper…

I can afford lots of stupid shit. Doesnt mean i'll buy it. But i guess that's a lifestyle choice.

Russian Bear
Guest
Russian Bear

Dear Dave,

You CANNOT use today's interest rates when you compare with historical trends. You have to use average historical rates as well. Why don't you redo your calculation using more realistic long-term rates, and let us know the results, which I am sure would not not work in your favor. Good Luck.

MrBear
Member
MrBear

arbitrage: Nod, nod. Wow, you must be my long lost twin who can complete my sentences for me!

mino3
Guest
mino3

27/33/51 using temporarily ultra-low interest rates? Wow, that's horrible affordability for such low interest rates. That means if you buy today (and lock in the principal) and interest rates merely revert to historical average (8%) in 5 years, the affordability line will look more like 50/60/100!

aregma
Guest
aregma

Thanks for the numbers Dave, very informative. I too would be interested in seeing what the numbers look like if the interest rates were fixed at say 6% over the years. Or use the 10 year fixed rates at the given times.

Thanks!

MrBear
Member
MrBear

mino3: Don't forget the plunge in resale value that would accompany that sort of uptick in interest rates. If rates went to, say, 10% I'd bet that a lot of people buying today wouldn't be able to refinance at all because they'd be underwater at the time. How crazy would you have to be to take that sort of risk?

Anonymous
Guest
Anonymous

Please give some detailed numbers of you caculation. i.e.

house price, income, rate…

Only a year now from 2008, affordbility improved from 75% to 51%, with house price only down about 10%. Really?

Yalie
Guest
Yalie

There is one more critical fact that the above analysis ignores – the fact that RE is cyclical and those cycles are loooong. A proper analysis needs to consider that fact that today's 'mid-range' affordability represents a market on the way down. Every single previous market cycle has bottomed out at a point BELOW the average, and we are currently on the downward swing from highs reached only 1 year ago.

Even if we assume that today's low interest rates are here to stay (a highly dubious assumption, as pointed out above), Dave's analysis assumes that the market will bottom out at the average mid-point of affordability. This is, of course, absurd.

Dave knows this very well. Why didn't he mention it?

Fish10
Guest

Guys please have a look at this post, so you can see how your tax dollars are about to be spent

http://tinyurl.com/cch77z

nornally lurking
Guest
nornally lurking

I call BS.

Prices and are rates are only a little lower than last year, and affordability goes:

Condo 40 -> 27

TH 50 -> 33

House 75 -> 51

You have either seriously fcuked up your calculations or are deliberately being deceptive. Since you went from rounding to not, and didn't provide your data or calculations, I'm going with the later.

nornally lurking
Guest
nornally lurking

Forget what "Dave" has to say (cough bullshit cough) about affordability and take a look at what TD has to say.

http://www.td.com/economics/special/gb0409_housin

Vancouver is covered on page 17 & 18. Entire report is worth a read.

Look out below.

buff_butler
Guest
buff_butler

2 points.

If by anyones calculations we are at "average" affordability then we will definitly have more to fall because we are in a recession and this is when affordability should be at its best.

Secondly using central interest rate of 0.5% for your affordability test is very poor financial planning. Your basically saying "I can afford this on the premis that banks won't want to make more money off my mortgage"

jesse
Member

Dave, interesting. So if we can assume that current interest rates will not substantially rise for the next few decades, affordability is once again sustainable.

If interest rates rise even by 1-2%, your model falls apart.

Also note affordability doesn't necessarily mean prices will stay flat. If there is enough supply and/or speculation in the market, or if there is a lack of liquidity or cash available to fund down payments, prices will fall regardless of what the affordability numbers say. In such a situation, those able to afford in the coming years will be duely rewarded.

betamax
Guest
betamax

buff_butler just wrote what I was going to. We can forget about "mid-range of historic affordability" in a recession, and rates have nowhere to go but up.

I'm sure Dave can crunch the numbers on some Florida swampland and discover it's a great deal too. Why Dave is once again getting a soap box here is beyond me. If I want biased bull spin, I can just read a paper or watch TV news.

realpaul
Guest
realpaul
Based on Daves aggregate non specific data the 'affordability' ratio is way worse than I thought. Bwahahahahahahah, thanks for the laugh Dave. Using Daves ( BTW Dave outed himself as a realturd on another site some time ago, so take what he says with that proviso in mind) data the income/price ratio is 10.66 X's average income!!!!!!!!!!! This is twice as unaffordable as Britian, Spain and the US, those markets are all in full on crash mode. We are the most overpriced unaffordable market on the planet save Moscow, even with the proviso that the average wages of a qualified buyer in Moscow is much higher than here, sad isn't it. Even in the millionaire rich streets of Manhattan the prices are crashing due to a lack of buyers. Obviously when prices are beyond the average persons ability to buy… Read more »
M-
Member

Dave: are you sure the RBC report doesn't normally use the "posted" 5-year rate, rather than a discount rate?

Currently the RBC posted rate is 5.45%.

http://www.rbcroyalbank.com/products/mortgages/vi

markx
Guest
markx

Have to say, Dave made a coherent and logical argument. The only response I can come up with, is the extremely low interest rate we currently have. Low interest rate generally accompany low wage growth, which means wages can not easily outgrow the mortgage payment, as it was the case in the 80s. Low interest rate also predicts slow economic growth, which means lower labour participation rate. All this doesn't bode well for RE.

51% may seem like a good deal, but affordability is even better now south of border, given their low mortgages rates AND much lower prices than Vancouver. Why are they not buying?

realpaul
Guest
realpaul
The banks aren't selling many bank owned homes so that the shadow inventory is not counted as many bank owned houses are not listed which phonies up the entire reporting of sales figures suspect. "Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down. "We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage. http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/… So don't… Read more »
cashisking
Guest
cashisking

60k/year after tax is what? 4k/month?

Benchmark house price is 650k

20% down would be 130k (how you would save on 60k a year is beyond me) … so mortgage at 5% on balance 3k + taxes + insurance

What am I doing wrong? … would I have to get rid of all my vices like a phone/internet, heat and light? Transportation? What does cat food taste like?

Are ya nuts?

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