Could housing affordability cause the next real estate crash?

The residential real estate market is on fire. Historically low interest rates coupled with a housing shortage have created the perfect fuel for values ​​to soar. According to the Case-Shiller Home Price Index, over the past two years, from November 2019 to November 2021, the median home price has increased by 30%. This rate, for many, is reminiscent of that of 2004 to 2006, just before the Great Recession, when house prices rose 28% in the two-year period, then crashed later.

Lending standards have improved a lot since then, suggesting that today’s house price growth is very different. However, there are other reasons to worry about another setback: affordability is one of them.

An accessibility crisis

Housing affordability has been a well-known issue for decades. It is estimated that up to 6.8 million households are missing to serve those living below the poverty line or earning less than 30% of the median local income. City and state municipalities, nonprofits, and the federal government are focused on creating housing for low-income people in our country.

But thanks to the rate at which house prices and rental rates are rising right now, it’s no longer low-income people who are left out of the market. Middle-income earners are starting to feel the pinch as affordability gets further and further out of reach.

Image source: Getty Images.

I can’t keep up

According to data provided by the Economic Policy Institute, from 2007 to 2022 wages have grown well below the target rate of 3.5% per year, creating a gap of $2.75 between where the hourly wage target should be and its current level. Not to mention that inflation, which has hovered between 1% and 3% for most of this period, offsets most of any wage growth. But the current inflation rate of 7% is wiping out years of income growth for American workers.

Housing rental rates have increased, on average, 8.86% per year since 1980, far outpacing wage growth and inflation. Single-family home prices have risen 102% over the past 10 years, averaging a 10% year-over-year (YOY) appreciation rate. It’s easy to see why affordability is a concern.

To better illustrate the problem, I will use a hypothetical housing example from my local real estate market, St. Petersburg, Florida. Let’s say you earn near the median income of $60,000. Your take-home pay after taxes should be around $49,000, or just over $4,000 per month. The average rent in the area is $1,771, which means you’ll need to spend 44% of your monthly income on housing, which is 14 percentage points above the recommended ratio of 30%.

Factor in other living expenses — such as fuel, food, childcare, utilities, or other debts like car payments, student loans, or credit cards — and you can easily see how even the average income is getting short.

Person sitting on the porch in front of the house with a for sale sign and looking gloomy.

Image source: Getty Images.

Can lack of accessibility really cause a crash?

Sluggish wage growth was already a concern when it came to housing affordability, but the current rate of inflation takes the problem to a higher level. Things like groceries, fuel, utilities and other services are getting more expensive — which is bad news for the millions of Americans who may have already struggled.

There is a tipping point. When the cost of living just gets so unaffordable for the average American, something will have to give. This could mean less overall spending, which limits economic growth and hurts jobs, or an increase in defaults, which strain the financial system and housing markets – or both.

Ultimately, the result will be a repositioning of how money is spent, and that will include money spent on housing. People may be forced to move to more affordable areas, while others will be forced to sell to avoid foreclosure. This influx of homes for sale could help ease the imbalance we see today and increase the supply of homes, helping to cool home price growth.

I think a real estate crash of Great Recession proportions is unlikely. I think, however, that affordability should not be overlooked as a serious concern or potential catalyst for a housing market correction.

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