Important trends to discuss this month are the connection between housing affordability and housing demand in California and the effects of rising mortgage rates. The chart on the next page compares the indices of three metrics—home price in California, the average 30-year mortgage rate in the United States, and per capita income in California—against housing affordability in California.
After the 2008 financial crisis, housing didn’t truly begin to recover until January 2012. As we can see from the chart, housing was most affordable in the first quarter of 2012 with 56% of the population estimated to have the means to afford a home. Within two years, affordability declined to a more steady state of around 30%. During the nine-year period that the chart depicts (Q1 2012–Q4 2020), homes in California, on average, increased in price over 80%. Of those homes, those in major metropolitan areas saw greater price appreciation. During the same period, per capita income increased around 40%, and mortgage rates moved between slightly under 3% to 5%, with an average of 3.87%.
Interest rates have an interesting effect on affordability, but income level, unsurprisingly, seems to have the most influence. According to the California Association of Realtors (CAR), the minimum qualifying annual income has increased 129% for single-family homes and 111% for condos since the first quarter of 2012. If we compare 129% minimum income increase to the 40% per capita income increase during that same time, we clearly see why homes have become broadly less affordable. Currently, 27% of Californians can afford a home, and that number will likely decrease over the next year.
Over the last 12 months, mortgage interest rates fell, hitting all-time lows in December 2020 at 2.66%, and demand skyrocketed. Typically, if all other factors are equal, a 1% drop in interest rates allows a buyer to afford a 13% higher price in terms of monthly payment. For example, a person paying 4% on a $1,000,000 mortgage pays the same amount each month as a person with a $1,130,000 mortgage at 3%. In California, the drop in interest rates caused a buying frenzy, dropping the already-low housing supply even lower.
Mortgage rates are starting to rise, although they still remain quite low by any historical standard, which will generally have an adverse affect on affordability. Affordability decreases as mortgage rates increase, because a 1% increase makes a home 13% less affordable on a monthly payment basis. Usually, demand would also decrease, which it is likely to do, to some extent; however, California is so undersupplied that it won’t matter. We may be at the start of an unusual dynamic of rising rates and rising home prices, which will drop affordability further.
Although we don’t expect the same level of buying in 2021 as we saw in 2020, the environment is right for demand to outpace supply. In the short term, we may even see a demand spike as those able to buy try to purchase before rates rise higher. We anticipate a competitive landscape for buyers over the course of this year.
Conversely, now is an exceptional time to sell your home. Low inventory means multiple offers and fewer concessions. Our only note is that sellers are often selling one home and buying another, which makes working with the right agent even more important.