Are DC Area Housing Prices Outpacing Income?

By Art Rodgers

Recent articles and posts everywhere, including Greater Greater Washington, have talked about how housing is becoming unaffordable.  However, the graph below suggests that home prices may be more affordable now than they were in 1990.  It was constructed by calculating the purchasing power of household income using prevailing mortgage rates and comparing it to the growth of the Case-Shiller Index over time.

 

Source: HUD, FHLMC, S&P Case-Shiller, DC Office of Planning.

Source: HUD, FHLMC, S&P Case-Shiller, DC Office of Planning.

In 1990 the US Department of Housing and Urban Development (HUD) estimated the Area Median Income (AMI) for the Washington Metropolitan Statistical Area (MSA) was $51,000, and according to FreddieMac the average interest rate for a home mortgage was 10.13 percent!  This suggests the typical household could afford a mortgage of about $144,000[1].  Over time the AMI went up and interest rates went down.  In 2012 HUD estimates the AMI is $107,500 and interest rates average 3.5 percent.  Using the same calculation, the same typical household can now afford a mortgage of $595,000.  When the average annual rate of change in the Case-Shiller Index is applied over time to the same starting point of $144,000, the index suggests a current home price of $527,000.

So yes, housing prices have outpaced household income, but this analysis suggests that it’s primarily due to increased buying power from low interest rates that has inflated housing prices and not a gap between supply and demand or other factors.  If this is the case, it raises some different, but vital questions the region should be asking:

  • If prices are up in large part due to interest rates being kept perhaps artificially low?  What happens when those rates go back up? The Federal Reserve’s program of quantitative easing seeks to offer a soft landing to keep housing prices stabilized.  But unlike everything else, the saying for interest rates is “what goes down must come up.”    A simple increase in interest rates from 3.5 percent to 4.5 percent reduces purchasing power by $67,000 or 11 percent.  Renting will become more attractive. However, to the extent this affects housing prices, how will local budgets be affected by potentially even lower property values?
  • The problem is perhaps not a shortage of housing, but where the housing is in relation to the jobs.  Drive till you qualify is certainly part of the problem.  OP’s study on housing & transportation costs estimated that lower transportation costs in the District can save a household on average $4,000 to as much as $16,000 annually compared to the outlying suburbs, but the lending industry doesn’t recognize the savings from low transportation costs or the expense of a high cost area when underwriting loans.
  • It’s also the region’s overall imbalance, where all the jobs are to the west and all the lower cost housing is to the east.  In Prince George’s County the median sales price is $177,500 and demand has only recently taken note of the opportunity.  The imbalance adds to the region’s traffic congestion, longer commutes, etc.  Therefore, how can we fix the regional jobs/housing imbalance, and create greater housing affordability to the west and more jobs to the east and help people live closer to their work?
  • Finally, the growing barbell distribution of household income is making it harder for a larger percentage of households on the lower end to afford homeownership.  Homeownership does confer several benefits of greater housing cost stability and asset development that can help raise intergenerational wealth.  How can these benefits be extended to a wider range of households while growing the stock of affordable units as population increases?

[1] Using the standard 30 percent of income toward housing costs.  Down payment requirements held constant.