April 2007

Moderator: Welcome to this podcast from EconSouth, a free quarterly publication issued by the Federal Reserve Bank of Atlanta. Our topic today is housing affordability, and we're talking with Atlanta Fed research economist and policy adviser Julie Hotchkiss. For the first question, I wanted to bring up the housing affordability index, which has declined sharply since 2003. Please explain what this change means and how it could affect most homeowners.

Julie HotchkissJulie Hotchkiss: There are three different reasons why the affordability index can decline. First of all, family income can decrease, the price of homes can increase, and the cost of purchasing a home, such as mortgage rates, can also increase.

Even in a local real estate market where housing prices have remained relatively stable, the rising interest rates affect everybody wanting to buy a house. This probably makes this contributor to affordability the most important nationally.

Both family income and home prices vary a lot across geographic areas, and it's really the relative growth of these two components that matter. For example, between 2002 and 2005, Florida saw an average annual 3 percent increase in median family income, but a whopping 22 percent average annual increase in home prices. In contrast, while Georgia, Alabama, and Tennessee also saw increases in family income of about 3 percent per year, home prices in these states only rose about 6 percent annually over the same time period. The implication is that housing affordability dropped much further in Florida than in other nearby states.

Getting to the second part of your question, clearly a drop in affordability means that fewer families will be able to purchase a home, and homeowners will have a harder time selling their home if they want to move. The appreciation of home prices, however, does mean that an important long-term asset is growing in value, which does feel good from a net worth perspective.

Moderator: How does housing affordability affect the homeownership rate, which remains high, at about 70 percent?

Hotchkiss: A decline in housing affordability could have two possible effects on homeownership. It could make someone give up the idea of owning a home and induce them to just continue to be a renter. This, of course, would reduce the home ownership rate. Or, it could just make them more selective on price, and they end up owning a smaller or lower-quality house than they might otherwise have. The home ownership rate has declined a very small amount in the U.S. overall: by about 0.2 percentage points from 2004 to 2006. But on a base of 109 million occupied housing units, this corresponds to about 219,000 households that will be renters instead of homeowners. Interestingly enough, the homeownership rate in Florida has not declined very much at all from its high of 72 percent of households.

Moderator: What effect have new mortgage products had on housing affordability?

Hotchkiss: One of the components of the Housing Affordability Index is how much income is required to qualify for a conventional 20 percent down payment, fixed-rate mortgage. So, technically, the availability of unconventional mortgage products will not factor into the calculation of the technical housing affordability index. However, the new mortgage products have clearly qualified more people for buying a house than would have been able to do so without them. Observing that, one might argue that these mortgage products made housing more affordable for some people. However, I would argue that home ownership is really more accessible through these products, not necessarily more affordable.

Moderator: What impact does housing affordability have on other sectors of the economy?

Hotchkiss: The place where we have seen the adjustment to declining housing affordability the greatest is in construction employment. As builders scale back their projects, fewer workers are needed. In February of this year, national construction employment declined from a year ago for the first time since 2003. After reaching its peak growth of about 14 percent, construction employment in Florida grew under just 2 percent in January from a year ago.

Moderator: For the last question, as the housing market has continued to slow in many parts of the South, do you expect the housing affordability index to change?

Hotchkiss: Certainly as a product becomes more expensive, or less affordable, economic theory tells us that less of the product will be demanded. And this is exactly what we've seen. So as affordability declines, we should expect to see sales fall, prices fall, and construction fall. This is the way the marketplace adjusts to being out of balance.

The evidence of this adjustment can be seen in the movement of the affordability index itself. The decline in the index has slowed from a 10 percent decline between 2004 and 2005 to a 5 percent decline between 2005 and 2006. As the growth in house prices gets closer to the growth in family income, and as long as interest rates don't take off, this will improve housing affordability. The most recent preliminary estimate of housing affordability, which is available for January 2007 for the nation as a whole, sits at 116, up from 112 in 2005, but that's a long way to go to get back up to 130, which is where affordability was in 2003.

Moderator: Thanks, Julie. Again, we've been speaking with Atlanta Fed research economist and policy adviser Julie Hotchkiss. This concludes our EconSouth Now podcast on housing affordability. For more information please see the first quarter 2007 edition of EconSouth. From our Web site you can read the full article or subscribe to EconSouth in print. Thanks for listening, and please return for more podcasts. If you have comments, please send us e-mail at podcast@frbatlanta.org.