A Look at Real Housing Prices and Incomes: Some Implications for Housing Affordability and Quality

By Gyourko, Joseph; Tracy, Joseph | Federal Reserve Bank of New York Economic Policy Review, September 1999 | Go to article overview

A Look at Real Housing Prices and Incomes: Some Implications for Housing Affordability and Quality


Gyourko, Joseph, Tracy, Joseph, Federal Reserve Bank of New York Economic Policy Review


INTRODUCTION

In the 1980s, the affordability of a single-family home joined traditional housing issues such as substandard units and racial discrimination as a focal point of housing policy discussion. Despite an aging population, which should increase home ownership over time, the aggregate ownership rate declined by 1 percentage point during the 1980s. This marked a reversal of the trend over the past several decades toward higher aggregate home ownership rates

In this paper, we update this affordability debate using data from the 1990s. We follow Gyourko and Linneman (1993) in addressing the affordability issue by asking a simple question: Is a home of a given quality from ten or twenty years ago more or less affordable today to a household similarly situated to the type of household that occupied the home a decade or two ago? It is important to determine whether the prolonged economic expansion of the 1990s has significantly improved affordability for households at the bottom of the income distribution. Real house prices at the lower end of the price distribution fell during the 1990s. However, our concept of affordability also hinges on the trends in constant-quality house prices for which, heretofore, there have not been estimates for the current expansion.

Also in need of reexamination is Gyourko and Linneman's conclusion that housing quality at the lower end of the house price distribution is rapidly deteriorating. We introduce a new estimation technique that suggests that the quality of high-end homes may have improved more and the quality of low-end homes may have deteriorated less than has been suggested in previous research. This analysis also has implications for the Clinton Administration's desire to expand home ownership, particularly among lower income households. It strikes us as virtually impossible to tell whether or not this is a good idea without knowing whether the quality of lower end housing really is falling and, if so, if it is the deterioration's proximate cause. If the quality decline is real, and if it reflects an inability of low-income households to afford adequate maintenance, then it may be misguided to encourage more low-income households to place their wealth in owner-occupied housing. While we cannot answer the question here, our analysis suggests urgently needed research.

II. WHAT DO WE MEAN BY HOUSING AFFORDABILITY?

Linneman and Megbolugbe (1992) note that how affordability is defined can have important policy consequences. For example, the most widely known affordability index, published by the National Association of Realtors (NAR), is constructed such that an index value of 100 implies that the median income family qualifies for the median value home. Because interest rates are more variable than incomes, changes in the NAR index over time primarily reflect variations in mortgage rates. Given current low long-term interest rates, the NAR index indicates that singlefamily housing is now more affordable than at any time in the last twenty-five years. This is evident in Chart 1, in which we overlay the NAR's Composite Homebuyer Affordability Index against the thirty-year fixed-rate mortgage rate.1 Improving housing affordability as measured by the NAR index points to mortgage subsidy programs and policies that act to lower long-term interest rates.

Work by Jones (1989) and Linneman and Wachter (1989) implies that these policies would be insufficient to deal with the real affordability problems facing many households. These researchers have found that down payment requirements have a significant impact on the ability of many households to buy a home. While lower interest rates reduce the income necessary to purchase a home, they do not directly reduce the down payment requirements. As a consequence, the levels and growth rates of savings and incomes, in addition to house prices and interest rates, are key components of housing affordability. …

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