Despite rising interest rates and eroding housing affordability, the average cost of home ownership in the US as a percentage of income is extremely low, according to a new report by Grosvenor Research.
“The cost of owning a home in the US as a percentage of household income is now about ten percent, well below the 20-year average of about 14 percent and the 34-year average of more than 17 percent,” said Eileen Marrinan, Director of Research for Grosvenor Americas. “In contrast, the cost of renting as a percentage of income is much higher at almost 14 percent.”
This is a somewhat surprising finding, Marrinan commented, because rising interest rates are definitely impacting housing supply and affordability. The Federal Reserve’s “quantitative easing” (QE) program of large-scale bond purchases drove the average US 30-year mortgage rate down from five percent in early 2011 to a low of 3.5 percent in late 2012. In response, US home sales escalated, residential construction activity began to pick up from historically low levels, and prices posted several months of double-digit gains.
In May 2013, after the Fed announced plans to start tapering QE purchases, interest rates escalated significantly; in response, housing market activity began to slow. After reaching a post-recession peak of 5.8 million in the summer of 2013, total home sales declined in each of the next three months. Existing home prices continued to appreciate but at a more moderate rate. Residential permitting and construction starts declined during the summer of 2013, normally homebuilders’ busiest season.
But as 2013 drew to a close, activity began to pick up once more. New home sales, which averaged 388,000 per month between June and August, escalated to 437,000 per month between October and December, 14 percent above the year-ago average (Because the housing market is highly cyclical, activity measures are typically compared to the previous year’s rather than the immediately preceding time period). Fourth quarter housing starts surged 15 percent above their fourth quarter 2012 level, to an annual rate of one million units.
“Some economists have expressed concern that higher interest rates could short-circuit the housing recovery,” remarked Marrinan. “A year of robust price appreciation coupled with the sudden spike in mortgage rates already has eroded affordability somewhat.”
And there’s little doubt that interest rates are on the rise, Marrinan went on. “Tapering of the Fed’s QE bond purchases began in January of this year, and is expected to continue throughout 2014,” she explained. “Interest rates will continue to trend up even after QE ends, however. With more robust and consistent economic growth, the Federal Reserve will begin to tighten monetary policy, allowing interest rates to rise. The ten-year Treasury rate is expected to regain its long-term average level of 5 percent by late 2016.”
Marrinan believes the US housing market will continue to recover, albeit at a more measured pace. “The cost of home ownership as a percentage of income is still extremely low from a historic perspective,” she noted. “So long as interest rate increases occur in tandem with stronger economic expansion, buyers should be able to accommodate higher financing costs.”
The big “if” mentioned by Marrinan is the same subject that’s on everyone’s mind: jobs and income. “Looking ahead, solid employment growth, resurgent household formation, and still-low mortgage rates should all support housing demand,” she noted. “But one key factor that has yet to materialize is healthy income growth.”