Written by First American Chief Economist, Mark Fleming
Once again, home buyers benefitted from a year-over-year affordability boost as two of the three key drivers of the Real House Price Index (RHPI), household income and mortgage rates, swung in favor of increased affordability in November. Compared with November 2018, the 30-year, fixed-rate mortgage fell by 1.2 percentage points and household income increased 2.6 percent. Both trends, rising household income and declining mortgage rates, boost consumer house-buying power.
“So far, rising house-buying power has been strong enough to overcome the pace of nominal house price appreciation nationally and in all top markets relative to last year, but that could change.”
However, increased house-buying power also drives demand, and rising demand in a supply constrained market results in faster nominal house price appreciation. This is exactly what occurred in November, as the final component of the RHPI, nominal house prices, continued to accelerate, offsetting some of the affordability tailwind from rising house-buying power.
Even as nominal house prices have gained momentum because of the supply and demand imbalance, real house prices actually declined by 8.1 percent thanks to the benefit of increased buying power. Since we know real estate is local, house-buying power and nominal house price gains vary by city, begging the question, where did affordability increase the most?
The Five Cities Where Affordability Increased the Most
Affordability improved year over year in each of the 44 markets we track. The five markets with the greatest year-over-year growth in affordability were:
1.) San Jose, Calif.
3.) Riverside, Calif.
4.) San Francisco
Declining mortgage rates increase affordability equally in each market, as mortgage rates are generally the same across the country. However, household income growth and nominal house prices vary by market, so the affordability dynamic varies as well. In November, San Jose had the greatest year-over-year increase in affordability, mostly due to slower nominal house price appreciation compared with the other markets. Baltimore had slightly higher nominal house price appreciation compared with Riverside, 5.2 percent and 5.8 percent respectively, but outpaced Riverside when it came to house-buying power, growing by 22 percent versus Riverside’s 21 percent.
Finally, the intricate dance between house-buying power and nominal house price appreciation becomes clear when comparing the cities taking the final top spots: San Francisco and Denver. The improvement in affordability in San Francisco was slightly greater than Denver due to slower nominal house price appreciation (3.0 percent versus Denver’s 4.2 percent), even though house-buying power in Denver outpaced San Francisco by 0.6 percentage points.
Increased Affordability Drives Demand
Nominal house price indices overlook what matters most to potential buyers – their purchasing power, or how much they can afford to buy. Rising house-buying power due to lower mortgage rates and strong income growth boosts affordability and drives demand. However, when demand increases for a scarce good, such as housing, prices will rise faster.
The net effect of these dynamics will determine the trend in affordability in 2020, and thereby impact home-buyer demand. So far, rising house-buying power has been strong enough to overcome the pace of nominal house price appreciation nationally and in all top markets relative to last year, but that could change.