The Rising Threshold of Homeownership Affordability

Over the past several decades, we have heard from clients expressing interest in purchasing a home. Many believe that buying a primary residence is an investment and they intend to treat is as such, when in fact, the data over the same period demonstrates the opposite. Comparing an investment in the SP 500 index to the purchase of an average residential property, for example, an investor would have realized a significantly higher return on their capital. Since 2020, the economic landscape has been in constant flux, a condition that has particularly affected both the stock and the housing markets. This article explores the misleading data asserting homeownership vs. indexing as a means of building wealth.

The aspirational goal of owning a home, a core component of the American dream, has become increasingly difficult to achieve. Previously, the expectation of earning a six-figure income to purchase a median-priced home was limited to a select few regions. This barrier was primarily seen in states known for their high cost of living, such as those with bustling urban centers or robust technology sectors.

However, in a relatively short span, this high-income prerequisite has proliferated extensively. According to a recent study performed by Bankrate.com, a significant number of states—22, to be exact, along with the District of Columbia—have joined the ranks where a household income of $100,000 or more is the baseline to afford a median-priced home. This change signifies a substantial shift in the financial threshold for homeownership, pushing the goalpost further for the average American.

This widening gap between home prices and income growth has several drivers. Factors include a limited housing supply, increased demand, and economic policies that have led to fluctuating interest rates. These conditions have combined to create a market where the valuation of homes outpaces the rate at which many potential buyers’ incomes grow. As a result, regions that were once considered affordable are now seeing home prices that align with what one would expect in traditionally expensive housing markets.

This phenomenon presents a challenge not only for first-time homebuyers and for those looking to relocate or seeking to own property as an investment, but also for smart investors whose goal is to build wealth. The dream of homeownership, once accessible to a broad middle class, now requires financial acumen and planning to achieve, especially in the most impacted states.

Defining “Affordable”

The term “affordable” can be nebulous, influenced by a variety of factors beyond income, such as savings, existing debt, and the costs associated with owning a property. Our analysis at Global Advisers is based on the presumption that investors should always seek the best possible investment opportunities, as based on a variety of economy, market, and historical factors. As it pertains to the current housing situation, this includes viewing mortgage payments, including principal, interest, property taxes, and insurance as opportunity costs.

Prudent Assumptions in Affordability

We base our affordability assessments on a hypothetical buyer making a 20% down payment on a 30-year fixed-rate mortgage. The mortgage payments are capped at 28% of the buyer’s gross annual income, an approach that suggests an annual income of $111,000 is necessary to manage a median-priced home in the U.S. However, income is not the only factor investors need to consider. Homeownership includes various expenses such as taxes, maintenance, and repairs, which over time, diminish an investors overall long-term returns as compared to other, less expensive investments.

A Geographical Disparity in Income Requirements

In the current real estate market, the cost of purchasing a median-priced home on the West Coast and in the Northeast has necessitated substantial household incomes, reflecting the high cost of living and the competitive housing markets in these regions. For instance, California, with its bustling economy, thriving tech industry, and desirable coastal locations, now requires a household income of $198,000 to afford a median-priced home. This figure is indicative of a broader trend in which prime locations and high-demand areas command premium pricing, directly influencing the income needed to secure homeownership.

Following California are other areas where the economic demand for housing continues to surge. Hawaii, with its unique island lifestyle and limited land for development, necessitates an income of $186,000. The District of Columbia, home to the nation’s capital, with its political and historical significance, as well as high-paying jobs, requires an income of $168,000. Massachusetts and Washington State, both with robust economies and high living standards, also demand significant incomes of $162,000 and $157,000, respectively.

This stark requirement contrasts sharply with the more modest income needs in the Southern and Midwestern states. For example, Mississippi requires an income of $63,000, and Ohio demands $64,000, almost a third of what is required in the more expensive states. This discrepancy is largely due to factors such as lower living costs, different economic structures, and varying degrees of urban development.

The result is a divided housing landscape, where the dream of owning a home remains relatively attainable in some states while becoming increasingly elusive in others. This divide not only reflects the economic variances across the U.S. but also underscores the importance of location in the real estate market, where regional dynamics play a critical role in determining the cost of living and the affordability of housing.

The Shift in Income Needs Since 2020

When measuring affordability, the most telling figures are those that show the increase in income required to afford a median-priced home. Since 2020, Montana has seen the most significant jump, with a 78% increase in the required income. Other states experiencing substantial increases include Utah, Tennessee, South Carolina, and Arizona.

Current Homebuying Challenges

Today’s potential homeowners grapple with soaring mortgage rates, rising home prices, and low inventory—all of which compound the difficulty of entering the housing market. For instance, a median-priced home in the U.S. now necessitates an income nearly 50% greater than just four years ago.

The Investment Perspective

In our analysis comparing real estate to the stock market, it’s worth noting that investment in indices like the S&P 500 often yields better long-term results than the residential property market. There is also a significant difference in the amount if time, effort, and ongoing expenses incurred when investing in a residential property vs. indexing. Homeowners who are eager to buy real estate often overlook these expenses and time commitment, often leading to frustration, disappointment and eventual downsizing or return to a return to a rental agreement with a landlord. By contrast, their is virtually no notable time commitment when indexing, fees are extremely low, and there is no account maintenance required, other than perhaps an annual revivification of employment and income by the brokerage firm that custodies the assets. Taxes are another consideration. The average homeowner pays approximately 3-4% of the properties value in property, local, and school taxes, whereas index investors pay taxes only on dividends and capital gains.

The biggest mistake we see investors make is presuming that all real estate investing is the same. While there may be opportunities in select commercial real estate, such as multifamily units, residential property typically does not offer the same potential for growth. In addition, there is no real positive net-cash flow from residential property, especially when taking into account the amount of labor, cost of repairs and maintenance, and taxes.

Nevertheless, some investors believe that buying a house is a good investment, even though the resilience and growth seen in the equity markets typically surpass the appreciation rates of average home prices in the U.S., underscoring the stock market’s role in wealth creation. Whatever reasons some investors hold for preferring real estate vs. indexing, they are all emotionally based and are not rooted in data, logic or facts as presented below.

The Numbers

• In 2003, the U.S. housing market was beginning to heat up, leading to the mid-2000s housing bubble. The S&P 500 also had a strong year in 2003, recovering from the early 2000s recession.
• By 2012, both the housing market and the stock market had started to recover from the 2008 financial crisis, with the housing market beginning its steady climb from the lows reached during the crisis.
• Fast forward to 2023, the average U.S. home value has seen significant growth since the financial crisis, while the S&P 500 has also provided robust returns, despite economic uncertainties and the impact of the COVID-19 pandemic.

The following comparison underscores the differing risk and return profiles of real estate versus stock market investments, highlighting the importance of diversification and considering long-term trends when making investment decisions.

To determine which investment would have performed better over the past 20 years—investing in the S&P 500 Index or purchasing an average residential house in America—we’ll calculate the value of a $100,000 investment in each case.

Starting Assumptions:

• Initial Investment: $100,000
• Period: 20 years

Growth Data:

• Average U.S. Home Value in 2003: Approximately $140,000
• Average U.S. Home Value in 2023: Approximately $340,000
• S&P 500 Return (2003-2023): 174.1% cumulative over the period (not including dividends for simplicity)

Calculations:

For the average U.S. home:

• The increase in home value from $140,000 in 2003 to $340,000 in 2023 represents a growth of approximately 143%.
• An initial investment of $100,000 in the housing market would theoretically be equivalent to purchasing a proportionate share of a home valued at $140,000 in 2003.
• Thus, the equivalent final value of that investment in 2023 would be calculated based on the same 143% growth.

For the S&P 500:

• A 174.1% return on the S&P 500 means that an initial investment of $100,000 would grow by 174.1% over the 20-year period.

Let’s calculate the final value of each investment after 20 years.

For the average U.S. home, with an initial equivalent investment of $100,000 growing by 143% over 20 years:

• Final value = $100,000 * (1 + 1.43) = $100,000 * 2.43 = $243,000

For the S&P 500, with an initial investment of $100,000 growing by 174.1% over the same period:

• Final value = $100,000 * (1 + 1.741) = $100,000 * 2.741 = $274,100

Based on these calculations, the S&P 500 investment would have performed better, turning $100,000 into approximately $274,100 over 20 years, compared to the residential real estate investment which would have turned $100,000 into approximately $243,000 in the same timeframe. This analysis highlights the S&P 500’s potential for higher returns over the long term compared to investing in the average residential property in America, even before considering dividends, which could further enhance the S&P 500’s performance.

In conclusion, the landscape of homeownership in America has undoubtedly shifted, requiring a recalibration of what it means to afford a home. While the market continues to present challenges, it also beckons a strategic approach to personal finance and investment—one that we at Global Advisers are poised to navigate alongside our clients.