From the National Association of Realtors to the National Association of Home Builders to economists to even politicians, everyone seems to be citing standard home affordability calculations as evidence that the housing market is poised for a turnaround. They might be a little early in that assessment.
There are several of these calculations, each employing a slightly different methodology, but for the most part they take into account how much of a median-priced home a median household income can afford with conventional financing and current mortgage rate assumptions. All these measures show affordability improving nationally to record or near record levels. This is being driven by the depreciation in home prices and the lower interest rates.
Based on prices and mortgage rates alone, homes are more affordable than they have been in 30 years. But while this is true generally, it is not true of every market. Some have in fact seen prices appreciate and, as a result, affordability is actually lower. This variation is always the case, which is why it is important to always acknowledge that there are markets outside of California, Florida, Washington D.C. and New York. We just happened to have recently lived through a decade when there was more of a national trend (up and down) than is "normally" the case because of the credit explosion and implosion.
Unfortunately, median incomes are falling in many of the same areas most plagued by the highest level of home price declines. So while price depreciation may be higher, thus making homes more affordable, that depreciation in itself does not give consumers the confidence to make such a major purchase, especially since they are being constantly told that home prices will continue to fall and now their own jobs are in jeopardy. So like with stocks, the P/E ratio no longer matters when you have no faith in the future power of the "E."
While affordability is clearly important in selling a product at a microeconomic level, its application at a macro level can be extremely misleading. I've worked with an economist for the last four years, and we never could prove statistically that affordability was a significant predictor of changes happening in a market. Here's why: Median-income households do not represent the majority of home buyers in most markets. Home ownership is tightly correlated with income levels. All other things being equal, the higher the income, the higher the probability that someone is a homeowner.
So, in looking at existing home turnover and new home sales, growth in the number of higher income households matters more than growth in below-median-income households.
And beyond trying to assess what's really happening with the true home buying segments, there is the issue of confidence in the future and the availability of credit, which clearly isn't being factored into these calculations.
Detroit is one of the most affordable markets in the country. Homes there are as affordable as they've ever been. Does that bode well for housing or the new home business there? Not when they are losing households, many of them home-owning households.
While affordability may be a useful metric, it is inadequate as a leading macroeconmic indicator of the housing market. It belongs somewhere on the cockpit dashboard, but the altimeter, fuel gauge and engine lights are a wee bit more important as we seek a safe landing.