Category: housing affordability

Homeless

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April 20, 2025

By Stephen Stofka

This is part of a series on persistent problems. The conversations are voiced by Abel, a Wilsonian with a faith that government can ameliorate social and economic injustices to improve society’s welfare, and Cain, who believes that individual autonomy, the free market and the price system promote the greatest good.

Abel waited until the waiter had finished pouring the coffee, then said, “This week, Trump is threatening to take away Harvard’s tax-exempt status. This country is becoming a banana republic where those in power use the state to go after their political rivals.”

Cain dribbled a small amount of sugar into his coffee then set the sugar packet on the table. “In his first administration, Trump put an excise tax on the biggest universities (Source). Certainly, there are a lot of religious conservatives who resent the denial of tax-exempt status to religious universities like Bob Jones University.”

Abel argued, “That was a long time ago and the issue was whether Bob Jones was a non-profit institution, not that it was religious. Colorado Christian University in Denver is tax-exempt, for example (Source).”

Cain replied, “Last week you talked about Make America Fair Again. One group of people perceive something as unfair, and that grievance helps bind them together. Another group of people faults the first group for being unreasonable, and the first group circles their wagons, convinced that they are being picked on. Remember when a lot of Tea Party groups were denied tax-exempt status?”

Abel nodded. “The IRS didn’t deny their applications, but put them on hold. Any applications with the words Tea Party or patriots in the name (Source). The agency was overwhelmed with 501(c)(4) applications for the 2010 midterms. One of the reasons they were overwhelmed was that Republicans had cut funding to the agency while they were in power.”

Cain set his cup down. “Perfectly rational explanations. Or a conspiracy? Rebutting a grievance with logical arguments is fruitless, yet we continue to do it. Expressing a grievance is a form of signaling to others. Political parties are built on shared grievances as well as shared principles, perspectives and values.”

Abel smiled. “Good point. This country was founded on shared grievances. ‘Abuses and usurpations’ the Declaration of Independence called them, and most of that declaration is filled with grievances, not the noble sentiments about life, liberty and the pursuit of happiness (Source).

Cain waited as the waiter set the food on the table, then said, “So we were going to talk about collective action problems, something other than the latest abuse by the mad king.”

Abel laughed. “That describes him well. His niece, Mary Trump, warned us in Too Much and Never Enough, the book she wrote about her Uncle Donald.”

Cain sighed. “In his second administration, we are discovering how rash he can be. He’s worse than any Democratic president I can recall for his interference in the economy and the market.”

Abel asked, “Worse than a President Bernie Sanders?”

Cain nodded. “Sure. Bernie has some respect for institutional rules. Trump couldn’t care less. Hey, we were going to talk about something other than Trump this week.”

Abel replied, “Right. I’ve been thinking about homelessness. You are always championing the role of incentives. I thought of a policy that would align incentives to allow more permissive zoning.”

Cain reached for his back pocket. “Let me hold onto my wallet.”

Abel laughed. “There are several characteristics of collective action problems and dealing with the homeless has several of those. People resist multi-family development for fear that it will lower the value of their home. Zoning that permits only single-family housing reduces the opportunities for developers to build more housing. A shortage of housing causes home prices and rents to rise, increasing homelessness.”

Cain interrupted, “Less supply, higher housing costs. Classic supply demand response. But rising home prices are a good thing for an existing homeowner. Naturally, they want policies that preserve the value of their asset.”

Abel nodded. “That’s my point. What’s good for each individual homeowner may not be good for society as a whole. Individual benefit, group loss. Garret Hardin pointed that out in his essay Tragedy of the Commons (Source). Each herder has an incentive to graze their animals on common land, land that no one owns. Together, they overgraze the area and there is no grass for anyone.”

Cain frowned. “Residential land is privately owned.”

Abel argued, “But the zoning is like a common resource. Also, homeowners in single-family zoning are contributing to the homeless problem but paying nothing for the extra city resources needed to deal with the problem. So, they are free riding in a sense, another characteristic of collective action problems.”

Cain finished chewing. Wait. Homeless people are the biggest free riders, but you chose to focus on the hard-working homeowners.”

Abel shook his head. “I’m just pointing out the free-riding aspect of the zoning problem.”

Cain argued, “I hate when liberals say the homeless problem is a zoning problem. Zoning is a relatively small part of the problem.”

Abel replied, “Well, let me finish. Third, there’s the public goods aspect. Presumably, everyone in the city benefits from less homelessness and no one can be excluded from those benefits. Less communicable disease. What else? A sense of pride in the city? And fourth, the homeless detract from people’s enjoyment of public parks, so there’s that aspect of the collective action problem.”

Cain put down his fork. “That’s a nice analysis. Let me come at it from a different angle. Incentives. Look at the incentives to be homeless.”

Abel scoffed, “What? Like free rent?”

Cain argued, “Why do homeless people gather in cities? They like the anonymity. It gives them a sense of independence. They rely on medical services far more than the general population (Source). There are outreach programs available to supply them with food, shelter and clothing. In some cases, inexpensive tents (Source). All of that charity makes homelessness at least more tolerable. One part of the solution is to make it less tolerable.”

Abel interrupted, “What? Put them in jail? Refuse them medical service and let them die? Last week, you said that we should build policies around price incentives. This week, you’re saying let’s build policy on a framework of cruelty?”

Cain smirked. “Give me a break. Last week I said that the price system is thousands of experiments in opportunity costs. Give up this to get that.”

Abel nodded. “The trade-offs act as a counterbalancing mechanism. Homeless people are often beyond the bargaining of trade-offs. In the case of addiction, they’ve already traded their family, their job, their stability for the hamster cage of drug addiction. Those with mental health issues may not be capable of recognizing the choices involved in a trade-off. They may hear voices and imagine conspiracies. Then there are those who are working but are too poor to afford rent in an expensive area. They didn’t voluntarily make a choice to become homeless. Circumstances boxed them in.”

Cain shook his head. “Or there own choices boxed them in.”

Abel argued, “So you’re going to punish them for making bad choices? Isn’t homelessness punishment enough?”

Cain frowned. “Why do homeless people tend to congregate in one area? The police allow it. It attracts more advocates for the homeless who bring food and clothes, the support system that enables their homelessness. The city should prevent such encampments. Why doesn’t it? Policy decisions from liberal politicians who follow Marx’s rule of distributing stuff according to need, not ability. They sacrifice the well-being of their hard-working citizens to tolerate homelessness.”

Abel shook his head. “How many cops want to get involved in restraining and removing people who are not right in the head or on some kind of drug? Cops are likely to quit one police force and join one in a neighboring district where the homeless problem is less acute. It’s a complex problem.”

Cain asked, “So what’s your policy solution?”

Abel shrugged. “Not a solution, but something that would address the zoning aspect of the problem. What if there were a property tax charge for every subdistrict in a city that had single-family zoning? People would then be paying annually for a zoning regulation that they think preserves the value of their property. I would call it an equity insurance fee rather than a tax.”

Cain replied, “I live in a neighborhood that is zoned for single-family homes only. So, I would see a separate charge on my property tax bill for that zoning?”

Abel nodded. “Yes. Connecting the annual cost to the benefit you receive from the zoning.”

Cain raised his eyebrows. “How I would react would depend on the percentage change in my property taxes. If it was another $100 a year, I might not object. But you want to make it cost enough that it would encourage homeowners in a single-family zone to lower their resistance to multi-family development.”

Abel nodded. “That’s the point. I don’t know what percentage increase would do that.”

Cain replied, “Essentially, single-family zoning would become a privilege that only those with higher incomes could afford to pay. Last week, you talked about Make America Fair Again. How fair is that policy to homeowners in older, more established neighborhoods? They are more likely to be retired and on fixed incomes. Already, they resent the increase in their property taxes from higher assessed valuations. Now the city is going to impose yet another fee on them.”

Abel sat back in his seat. “No policy can be fair to everyone.”

Cain objected, “What if there is no visible sign of homelessness in a neighborhood? Homeowners may not see the necessity of such a policy. They will be motivated to vote against it. I like the analysis, though. Shows the complexity of these problems. A viable solution would address all four of those aspects.”

Abel agreed, “You always emphasize the relation between prices and incentives. Homeowners are not incentivized to adopt policies that will increase the supply of housing if it will make the value of their property decline.”

Cain replied, “Exactly. Any policy you put in place will act against that natural tendency. You call it an insurance fee, but since it applies to all homeowners in a district, it acts like a tax. Unlike a price, a tax does not obey the natural forces of supply and demand.”

Abel argued, “A tax raises the price and higher prices reduce demand.”

Cain shook his head. “Yeah, but prices react to something real. They react.”

Abel shrugged. “Can’t see the difference. A tax reacts to something real. In this case, it’s homelessness.”

Cain argued, “The tax you are proposing is an incentive, not a reaction. It is a stimulus you hope will get homeowners to adopt a more lenient attitude toward permissive zoning. Take this, for comparison. A city does not impose a sales tax because they hope it will dissuade people from buying goods. The tax is a reaction to city’s need for revenue to fund the services it provides.”

Abel replied, “So called sin taxes are meant as incentives to get people to buy less.”

Cain laughed. “Don’t try to sell your insurance fee as a sin tax. Owning a home isn’t a sin in anyone’s playbook.”

Abel moved his plate aside. “So, Trump’s tariffs are meant as incentives or punishments and they distort the market.”

Cain nodded. “Before the 16th Amendment, tariffs were the chief source of revenue for the federal government. They served other purposes, yes, but they generated much needed revenue. Today, any tariff revenue would be a drop in the bucket. Trump’s tariffs act as carrots and sticks. That may be the extent of all of Trump’s policies. Carrots and sticks.”

Abel frowned. “There are a lot of carrots and sticks in the income tax code. Tax deductions for college expenses, health insurance, retirement contributions. These are all attempts to get people to do more of something that they would naturally. So how can saving for retirement or going to college distort the market?”

Cain replied, “Tax-advantaged plans were introduced in the 1970s (Source). The financial sector manages trillions of dollars in retirement accounts. That gives it more market share and political power.”

Abel asked, “I take it you’re opposed to any tax whose primary purpose is to influence behavior, not collect revenue?”

Cain drew a deep breath. “I do, but I’m a realist. People get into politics because they want to exert their values, their sense of justice on other people. Now we’ve got someone in the White House who takes that to the limit. I worry for the free market system. I worry for democracy.”

Abel raised an eyebrow. “You weren’t worried last November?”

Cain smirked. “You are more of an institutionalist, but I think I trusted in the institutions that have kept this country together for more than two hundred years. The institutional rules as well as the laws. Seeing long-standing practices fall so quickly has made me question the strength of those institutions. In a political sense, I feel homeless.”

Abel asked, “You think there was insider trading going on while Trump flip-flopped on tariff policy?”

Cain nodded. “Sure. The SEC is not going to investigate. It seems like most of the government is being run by acting commissioners without Senate confirmation. Those of us who complained about the complexity of government are getting a chance to see what it is like when a bunch of loyalists run the government.”

Abel stood up. “I am afraid that we are losing the world’s confidence in American institutions, particularly its currency. I’ll see you next week.”

Cain seemed lost in thought for a minute. “Yeah, next week.”

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Image by ChatGPT in response to the prompt, “draw an image of a tent with a disheveled person poking his head out of the opening of the tent.”

A Debate On Rent Control

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November 24, 2024

by Stephen Stofka

This is part of a continuing series of debates on economic and political issues. Substack users can find last week’s debate on climate change here. WordPress and other  users can visit my web site innocentinvestor.com here. Wishing everyone a good Thanksgiving this next week.

This week’s letter is about the price system, continuing an imagined conversation that began with last week’s letter. What is a price? Is it a measure? If so, it is not a good one because prices keep changing from year to year. Let’s imagine a haircut from the same stylist that costs 5% more in 2024 than in 2023. Did the quality of the haircut change? No. the service delivered is the same but not the price. So, what is price? It must be a good in and of itself – a commodity like wheat. A good that “evaporates” like water in the sun. The CPI calculator at the Bureau of Labor Statistics indicates that a $1 in 2024 buys what $0.50 did in 1995. Any interest earned on savings has barely compensated for the loss of buying power (see notes).

And now the conversation between Abel and Cain continues:

After the usual pleasantries, Abel said, “Last week I pointed out market failures where the price system in a free market does not control a negative externality like pollution. Another flaw in the pricing system is its inability to cope with social justice issues. Your group favors policies that emphasize growth. You claim that more growth will benefit everyone, including minorities. What about rent control? Land can’t grow. In densely populated cities like New York, the only way to grow the housing market is to build up. Zoning policies restrict the height of many residential areas, and the current residents prefer it that way.”

Cain replied, “Rent control is a price control and our group does not favor price controls in any form. They distort the supply and demand dynamics of a market. Rent control encourages landlords to make only those repairs which will avoid regulatory fines from housing authorities. The quality of the housing stock declines and that only contributes to the problem. Housing authorities must devote more resources to inspect properties, handle tenant complaints and regulate landlords.”

Abel interrupted, “So what’s your suggestion? In crowded markets like New York, the housing supply is too rigid, so it doesn’t shift to meet demand like in a supply demand model. If prices were allowed to find an equilibrium on their own, many working people would be priced out of the market. They would have to move further away from the city and drive long distances to get to work. This would choke an already overtaxed traffic and transit system. What’s your group’s answer? Let people move to another state? The tri-state area has already become a giant metropolis because families have tried that solution. The problem persists.”

Cain nodded. “Yes, there are choke points where circumstances or political interests constrict supply. The first question politicians should ask is ‘How can we adapt the price system to help manage this particular market?’ If we look at improperly maintained housing as a pollutant, perhaps policymakers could use a permit system or tradeable credits, the same system that has been successful with some pollutants.”

Abel asked, “How would that work? Make available a number of permits to not maintain housing units to safe health and safety standards? Housing can’t be turned into a lab experiment.”

Cain responded, “Each city may devise different pricing solutions. Some may work better than others, allowing competing policy frameworks to be tested in different circumstances. The point is that regulations and rent control should not be the first tool that policymakers reach for.”

Abel asked, “Has anyone used an incentive-based strategy using the price system to tackle the problem of affordable housing in a dense urban area?”

Cain replied, “Not that I am aware of.”

Abel argued, “Proves my point. Some issues cannot be resolved through the price system. People tolerate many inconveniences in a big city because there are many factors that induce them to stay.” Abel ticked them off on each finger, “Jobs, family, public transportation and infrastructure, civic associations with people having similar interests, schools for the kids, sports teams, the availability of internet, public institutions like libraries, internet, parks, museums.”

When Abel paused to take a breath, Cain interjected, “I get your point. A home of some sort in a city gives people access to amenities that are not available in a rural district with 2,000 residents. People want availability to all that stuff and pay as little as possible.”

Abel interrupted, “Are you saying that working people who spend half of their income on a place to live in New York City are freeloaders? It’s the upper income people that employ them who are freeloading. The rich are getting labor at an affordable rate. If working people could charge enough to cover their living expenses, they would get paid a lot more than they do.”

Cain argued, “It’s the rich people who are paying most of the state and local taxes that pays for all those amenities. The rich are subsidizing these institutions that the working class take advantage of.”

Abel said, “The median rent in the Bronx is 60% higher than the national average, according to an analysis by Zumper. The average monthly rent for a 2-BR apartment is almost $3500 and the  Bronx is one of the more affordable of the five counties in New York City. The national median annual wage for warehouse workers is $38,000, according to the BLS. That’s almost $3200 a month. A couple working two blue collar jobs would be spending more than half their gross income on rent. A prudent percentage is 30%, or less than a third of gross income. If New York City policymakers were to require employers to pay 60% above the national average, those warehouse workers would make almost $61,000 a year, or $5100 a month. Two incomes at that wage would total over $10,000 and that $3500 median rent in the Bronx would be about 34% of income.”

Cain dismissed Abel’s argument. “Those New York City employers wouldn’t be able to compete with other companies in surrounding regions with lower costs. They would leave or go out of business. There would be fewer warehouse jobs. That couple would have to compete with others for blue collar jobs. The increased supply of labor competing for jobs would further lower the market wage and make the couple dependent on social welfare programs. The city would have less tax revenue because those warehouse employers have left the city. Less property tax, less income tax, less tax on business income. The city could not afford to pay more benefits and might declare bankruptcy like it did in the mid 1970’s. A complex negative feedback loop. Policymakers who tinker with natural market forces only make the problem worse.”

Abel objected, “If that couple followed the signal of those market forces, they would move to a lower cost area in a nearby state. There would be fewer workers in New York City, driving up wages. As the couple tried to find work, they would drive wages down further in that nearby state. Those lower costs would enable employers to reduce their prices and put the New York City companies out of business.”

Cain responded, “In order to survive, those New York companies would also leave the city. Anyway, capital relocates faster than people. As soon as policymakers announced a law mandating that employers pay premium wages, a lot of blue-collar companies would relocate out of the city. Our blue-collar couple would be out of a job. Just as with a previous scenario, the couple would be dependent on the government for aid. The price system promotes independence.”

Abel protested, “Paying higher rents than the national average does not promote worker independence. A dense housing market is a seller’s market, a landlord’s market. Without some laws in place to protect renters, they would be entirely at the mercy of landlords. Market prices in a dense housing market like New York only promote independence for those with capital and access to capital like landlords.”

Cain shook his head. “Once again, your group and mine can’t agree. Your group blames capitalists for everything.”

Abel replied, “That’s overstating our objections. Capitalists promote a dynamic economy that responds to changing circumstances. But capitalists can’t operate only in the framework of the pricing system. In some markets, price dynamics often make the problem worse. As Keynes and other economists have shown, an unguided free market system can settle at equilibrium points that are below the productive capacity of a nation’s people and businesses. There is no automatic mechanism to move an economy to an optimal equilibrium of productivity.”

Cain turned to go. “Well, our group disagrees. The free-market system promotes growth, and it is growth that generates a productive equilibrium.”

Abel replied, “I know your group believes that, but belief doesn’t make it so. The housing market in New York City is just one example of market failure, the inability of prices to allocate resources. It is one of many.”

Cain replied, “Maybe we should talk about market failures next time we meet. Behind every market failure is a policy failure, believe me.”

Abel responded, “See you next time.”

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Photo by Shehan Rodrigo on Unsplash

Buying power note: Inflation has averaged 2.76% annually since 1995. The interest on a 1-year Treasury note (FRED Series DGS1) is similar to a 36-month CD rate and has averaged 2.6%.

Targets of Taxation

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April 28, 2024

by Stephen Stofka

The subjects of this week’s letter are home prices, household income and property taxes. The policy of using property tax revenue to fund public education has provoked controversy since the 19th century. Like other social species we are watchful of threats like freeloading to our group’s cohesion, however we determine “our” group. Newcomers to an area are often regarded with suspicion as being freeloaders who get from the group before they have contributed to the common welfare. This suspicion often underlies the heated debates that erupt at local council meetings. I will begin with property valuations, the basis of property taxation.

As a young man I was taught not to buy a home that was priced more than four times my income. In 2022, families paid more than six times the median household income, as shown in the chart below. Despite the high prices, mortgage debt service is a tame 10% of the household disposable personal income. Almost 40% of homeowners have a fully paid mortgage, according to Axios. Many homeowners hold mortgages at the historically low rates of the last decade. If higher mortgage rates persist for several years, we may see greater delinquency rates as recent buyers cope with payments that stretch their budget.

Graph shows an increasing ratio of home prices to median household income since 2000.

The Center for Microeconomic Data at the NY Federal Reserve has tracked household finances for more than twenty years. The highest percent of total household debt continues to be mortgage debt at 68% to 70%. Mortgage debt has grown at an annual rate of 3.9%, slightly more than the 3.7% annual increase in owner equivalent rent that I discussed last week. A low 3% of mortgages are more than 30 days delinquent, down from 11% to 12% during the 2008-2009 financial crisis. Only 40,000 people are in foreclosure, less than half the number in 2019. The numbers today are the lowest on record except for the pandemic years of 2020 and 2021 when many foreclosures were halted.

As I discussed last week, property prices reflect the anticipated cash flows from the house during a 30-year mortgage, a process called capitalization. The home buyer replaces the seller in the stream of cash flows from the house. Because property taxes are based on the appraisal values, the taxing authority implicitly bases property taxes on cash flows that a homeowner has not received yet. Each state sets an assessment rate that is a percent of the appraised value of the home. Each taxing authority within the state then charges a dollar amount – the mill value – per thousand of that assessed value. A home with an appraised value of $500,000 and an assessment rate of 8% would have an assessed valuation of $40,000. If the mill levy were $100 per $1000 of assessed value, then the homeowner’s property tax bill would be $4000. The effective property tax rate would be $4000 divided by $500,000, or 0.8%. Investopedia has a longer explanation for interested readers.

Each state taxes property at different rates. Colorado charges ½% of the appraised property value, one of the lowest in the nation. California averages ¾%. Texas averages a whopping 1.74% of home property values but has no income tax. Families earning the median household income and owning a house valued at the median house price in Texas and Colorado pay the same combined property and income tax of $5883 and $5669, respectively. Colorado has a cheaper tax burden despite having an income tax and far higher median house values. The same family living in California would pay $8256, largely because their property tax bill would be about the same as in Texas because the home values are more than double those in Texas. I will leave data sources in the notes.

Many districts give seniors a discount on their property taxes, effectively throwing a higher burden on working homeowners. Some argue that these exemptions should be means tested, effectively lessening or eliminating the discount for seniors with higher incomes. A wave of seniors may move to an inter-urban area that features lower home prices yet is within an hour of vital medical services like a hospital. The higher demand drives up home prices for others who have lived in the area for decades. Secondly, seniors consume more medical services and public accommodations. That requires more public spending, which is shared by the entire community and leads to resentments and contentious public meetings at the local town hall.

The majority of property taxes are used to fund public schools, and it is the largest line item on an individual homeowner’s property tax statement. This system of funding raises principled objections from childless couples and those who privately school their children, but are expected to share the burden of funding public schools. Homeowners have often resented having to fund the schooling of recently arrived immigrants. In the 19th century a wave of immigrants from Catholic Ireland, then Catholic Italy prompted many states with Protestant majorities to pass laws that excluded public funding for schools run by Catholics. Since the 16th century, the two main branches of Christianity had fought bloody civil wars in Europe and Britain. Those who colonized America brought those antagonisms with them.

During the 1970s, the number of encounters at the southern border increased almost ten times, according to the CBP. High inflation and migration of Amerians to western states caused a surge in property valuations and higher property taxes. In 1978, a taxpayer revolt in California led to the passage of Proposition 13 limiting property tax increases. In some school districts, undocumented parents had to pay a fee to enroll their children in public school.

In a 1982 case Plyler v. Doe, a slim 5-4 majority on the Supreme Court ruled that undocumented immigrant children did not have to pay a fee to go to school. The court reasoned that the equal protection clause of the 14th Amendment extended protection to “persons,” not “citizens.” Therefore, a state could not provide public benefits to one child in a school district and not another child because their parents were undocumented. The court interpreted “protection” to include public benefits, a construction that the Connecticut Constitution made explicit in 1818 with the phrase “exclusive public emoluments or privileges from the community.” The conservative majority on the Supreme Court overruled an interpretation of the due process clause in the 14th Amendment that justified the 1972 Roe v. Wade decision. This court might revisit this interpretation of the equal protection clause of the 14th Amendment as well.

Districts with lower property valuations struggle to raise adequate taxes to meet minimum educational standards. They may have to tax homeowners at a higher rate than a neighboring district, raising legal questions about uniformity and proportionality. The disparity in valuation was the subject of the 1997 Claremont decision by the New Hampshire Supreme Court. At the time, local districts provided 75% to 89% of funding for elementary and secondary education. The state’s general fund provided only 8% of school needs. The decision forced the state to distribute tax revenues among districts to meet adequate education standards for all children in the state. A 2017 analysis found that states now provide almost half of public education funding, relying on income tax revenue to smooth disparities in income among districts within each state.

People do not like paying taxes but grudgingly accept them. People elect local officials to decide on spending priorities yet some homeowners object to the way their taxes are spent. On my property tax bill are eleven items which include funding for schools, the city’s bonds, police, fire, libraries and flood control. Homeowners might prefer a questionnaire of thirty categories of spending which allowed them to allocate their tax dollars by percentage when they paid their property tax each year. In my district, a half-percent goes to affordable housing, three percent to social services. Some might prefer 5% or more. A homeowner paying online could elect to answer the questionnaire online. Would homeowners respond? Next week I will begin an exploration of various aspects of consumption, the chief component of our economy.

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Photo by Museums Victoria on Unsplash

Keywords: housing, home prices, mortgage, property tax

Property taxes by zip code and state can be found at Smart Asset
Median home prices by state are at Bank Rate
Median Sales Price of Homes Sold in the U.S. is FRED Series MSPUS at https://fred.stlouisfed.org/ Median Household Income in the U.S. is series MEHOINUSA646N. The ratio of mortgage payments to disposable personal income can be found here. The home price to property tax ratio can be found here

A Home Is More Than a Home

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March 31, 2024

by Stephen Stofka

This week’s letter is about housing, the single largest investment many people make. The deed to a home conveys a certain type of ownership of physical property, but the price reflects a share of the surrounding community, its economy, infrastructure, educational and cultural institutions. We purchase a chunk of a neighborhood when we buy a home.

These are network effects that influence demand for housing in an area. They are improvements paid for by tax dollars or business investment that are capitalized into the price of a home. Take two identical homes, put them in different neighborhoods and they will sell for different amounts. When elements of this network change, it affects the price of a home. Examples of negative changes include the closing of businesses or an industry, a decline in the quality of schools, the presence of graffiti or increased truck traffic. Positive changes might include improved parks and green zones, better schools and alternative transportation like bike lanes and convenient public transportation.

Zoning is a critical tool of a city’s strategic vision. Zoning controls the population density of an area, the available parking and the disturbance from commercial activities. Many cities have some kind of long-term plan for that vision. Los Angeles calls it a General Plan. In Denver it is called Blueprint Denver (pdf). Homes built in the post-war period in the middle of the twentieth century were often smaller. They feature a variety of building styles whose distinctive character and lower prices invite gentrification. As properties are improved, their higher appraisal values bring in more property tax revenue from that city district and the process of building an improved neighborhood network begins.

A representative for that district can argue for more spending on public amenities to enhance the neighborhood. This further lifts property values and increases tax revenues. Developers get parcels rezoned so that they can convert a single-family property into a two-family unit. This may involve “scraping” the old structure down to its foundation, then expanding the footprint of the structure to accommodate two families. As this gentrification continues, there is increased demand for rezoning an area to allow the building of accessory dwelling units, or ADUs, on a property with a single-family home. Here is a brief account of a rezoning effort in Denver in 2022.

In the past decade, the 20-city Case-Shiller Home Price Index (FRED Series SPCS20RSA) has almost doubled. The New York Fed has assembled a map with video showing the annual change in the index for the past twenty years. Readers can click on their county and see the most recent annual price change. Millennials in their late twenties and thirties feel as though some cruel prankster has removed the chair just as they started to sit down. Analysts attribute the meteoric rise in prices to lack of housing built during and after the financial crisis fifteen years ago.

Each generation faces a set of crises that stifle their ambitions. In the 1970s, just as the first Boomers were entering their late twenties, mass migration from the eastern U.S. to the western states and high inflation doubled home prices in some areas within just a few years. The decade is a comparison tool as in “How bad is it? Well, it’s not as bad as the ’70s.” The 1980s began with high interest rates, the worst recession since the Great Depression and high unemployment. Boomers had to buy houses with mortgage rates over 10%. Following that recovery was another housing scandal and the savings and loan crisis that restricted any home price growth. A homeowner who bought a home in 1980 might have seen no price appreciation by 1990. Gen-Xers who bought a home during the 2000s had a similar experience, leaving some families underwater or with little equity for a decade. Equity growth from homeownership helps support new business start-ups.

Despite the insufficient supply of affordable housing, there are more homes than households. In the graph below are the number of homes (orange line) and households (blue line) as a percent of the population. The difference is only a few percent and contains some estimate error, but represents many more homes than the number of households.

Graph showing homes and households as a percent of the population.

Household formation, the blue line in the graph above, is a key feature of the housing market. In 1960, 3.4 people lived in each household, according to the Census Bureau (see notes). By 1990, that number had steadily declined to 2.6 persons and is slightly under that today. The supply of homes naturally takes longer to adjust to changes in household formation. That mismatch in demand and supply is reflected in home prices.

During the financial crisis household formation declined as unemployment rose. Home prices fell in response to that change in demand for housing and a come down from the “sugar high” of easy credit and sloppy underwriting. The percent change in the Home Price Index, the red line in the graph below, fell below zero, indicating a decline in home prices, an event many homeowners had never experienced. The fall in home values crippled the finances of local governments who depended on a steady growth in the property taxes based on rising home values.

Graph containing two lines: 1) the percent difference between homes and households as a percent of the population, 2) the home price index. There is a large gap where the two series diverge during the financial crisis.

The thirty-year average of  the annual growth in home prices (FRED Series USSTHPI) is 4.5% and includes all refinancing. We can see in the chart above that the growth in home prices (red line) is near that long-term mark. However, rising wages and low unemployment have encouraged more household formation, the rising blue line in the first chart. Those trends could continue to keep the growth in home prices above their long-term average. Millennials with mortgages at 6-7% are anxiously waiting for lower interest rates, a chance to refinance their mortgages and reduce their monthly payments. Strong economic growth and rising incomes will continue to put upward pressure on consumer prices, slowing any decisions by the Fed to lower interest rates. These trends are self-reinforcing so that they take a decade or more to correct naturally. Too often, the correction comes via a shock of some sort that affects asset prices and incomes. Millennials have endured 9-11, the financial crisis and the pandemic. “Go ahead, slap me one more time,” this generation can say with some sarcasm. The challenge for those in each generation is to try harder and endure.

Next week I will look at the cash flows that a property owner receives from their home investment.

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Photo by Scott Webb on Unsplash

Keyword: interest rates, mortgages, mortgage rates, housing, households

Notes on series used in the graphs. The total housing inventory is FRED Series ETOTALUSQ176N divided by Total Population Series POPTHM. Total Households is TTLHHM156N divided by the same population series. These are survey estimates so some of the difference between the two series can be attributed to a normally distributed error. The all-transactions Home Price Index is FRED Series USSTHPI. The FRED website is at https://fred.stlouisfed.org/

Pocketbook Ratios

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January 21, 2024

by Stephen Stofka

Thanks to an alert reader I corrected an error in the example given in the notes at the end.

This week’s letter is about the cost of necessities, particularly shelter, in terms of personal income. Biden’s term has been one of historic job growth and low unemployment. Inflation-adjusted income per capita has risen a total of 6.1% since December 2019, far more than the four-year gain of 2.9% during the years of the financial crisis. Yet there is a persistent gloom on both mainstream and social media and Biden’s approval rating of 41% is the same as Trump’s average during his four-year term. Even though there are fewer economic facts to support this dour sentiment, a number of voters are focusing on the negatives rather than the positives.

I will look at three key ratios of spending to income – shelter, food and transportation – to see if they give any clues to an incumbent President’s re-election success (a link to these series and an example is in the notes). Despite an unpopular war in Iraq, George Bush won re-election in 2004 when those ratios were either falling, a good sign, or stable. Obama won re-election in 2012 when the shelter ratio was at a historic low. However, the food and transportation ratios were uncomfortably near historic highs. These ratios cannot be used as stand-alone predictors of an election but perhaps they can give us a glimpse into voter sentiments as we count down toward the election in November.

A mid-year 2023 Gallup poll found that almost half of Democrats were becoming more hopeful about their personal finances. Republicans and self-identified Independents expressed little confidence at that time. As inflation eased in the second half of 2023, December’s monthly survey of consumer sentiment conducted by the U. of Michigan indicated an improving sentiment among Republicans. The surprise is that there was little change in the expectations of Independents, who now comprise 41% of voters, according to Gallup. There is a stark 30 point difference in consumer sentiment between Democrats and the other two groups. A recent paper presents  evidence that the economic expectations of voters shift according to their political affiliations. A Republican might have low expectations when a Democrat is in office, then quickly do an about face as soon as a Republican President comes into office.

Shelter is the largest expense in a household budget. Prudential money management uses personal income as a yardstick. According to the National Foundation for Credit Counseling, the cost of shelter should be no more than 30% of your gross income. Shelter costs include utilities, property taxes or fees like parking or HOA charges. Let’s look at an example in the Denver metro area where the median monthly rate for a 2BR apartment is $1900. Using the 30% guideline, a household would need to gross $76,000 a year. In 2022 the median household income in Denver was $84,000, above the national average of $75,000. At least in Denver, median incomes are outpacing the rising cost of shelter. What about the rest of the country?

The Bureau of Labor Statistics (BLS) calculates an Employment Cost Index that includes wages, taxes, pension plan contributions and health care insurance associated with employment. I will use that as a yardstick of income. The BLS also builds an index of shelter costs. Comparing the change in the ratio of shelter costs to income can help us understand why households might feel pinched despite a softening of general inflation in 2023. In the graph below, a rise of .02 or 2% might mean a “pinch” of $40 a month to a median household, as I show in the notes.

Biden and Trump began their terms with similar ratios, although Biden’s was slightly higher. Until the pandemic in early 2020, housing costs outpaced income growth. Throughout Biden’s first year, the ratio stalled. Some states froze rent increases and most states did not lift their eviction bans until the end of July 2021. In 2022, rent, mortgage payments and utility costs increased at a far faster pace than incomes. Look at the jump in the graph below.

An economy is broader than any presidential administration yet voters hold a president accountable for changes in key economic areas of their lives. Food is the third highest category of spending and those costs rose sharply in relation to income.

Transportation costs represent the second highest category of spending. These costs have risen far less than income but what people notice are changes in price, particularly if those changes happen over a short period of time. In the first months of the pandemic during the Trump administration, refineries around the world shut down or reduced production. A surge in demand in 2021 caused gas prices to rise. Despite the rise, transportation costs are still less of a burden than they were during the Bush or Obama presidencies.

Neither Biden nor Trump were responsible for increased fuel costs but it happened on Biden’s “watch” and voters tend to hold their leaders responsible for the price of housing, gas and food. In the quest for votes, a presidential candidate will often imply that they can control the price of a global commodity like oil. The opening of national monument land in Utah to oil drilling has a negligible effect on the price of oil but a president can claim to be doing something. Our political system has survived because it encourages political posturing but requires compromise and cooperation to get anything done. This limits the damage that can be done by 535 overconfident politicians in Congress.

Voters have such a low trust of Congress that they naturally pin their hopes and fears on a president. Some are single-issue voters for whom economic indicators have little influence. For some voters party affiliation is integrated with their personal identity and they will ignore economic indicators that don’t confirm their identity. Some voters are less dogmatic and more pragmatic, but respond only to a worsening in their economic circumstances. Such voters will reject an incumbent or party in the hope that a change of regime will improve circumstances. Even though economic indicators are not direct predictors of re-election success they do indicate voter enthusiasm for and against an incumbent. They can help explain voter turnout in an election year. A decrease in these ratios in the next three quarters will mean an increase in the economic well-being of Biden supporters and give them a reason to come out in November.

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Photo by Money Knack on Unsplash

Keywords: food, transportation, housing, shelter, income, election

You can view all three ratios here at the Federal Reserve’s database
https://fred.stlouisfed.org/graph/?g=1ejaY

Example: A household grosses $80,000 income including employer taxes and insurance. They pay $24,000 in rent, or 30% of their total gross compensation. Over a short period of time, their income goes up 8% and their rent goes up 10%. The ratio of the shelter index to the income index has gone up from 1 to 1.0185 (1.10 / 1.08). The increase in income has been $6400; the increase in annual rent has been $2400. $2400 / $6400 = 37.5% of the increase in income is now being spent on rent, up from the 30% before the increase. Had the rent and income increased the same 8%, the rent increase would have been only $1920 annually, not the $2400 in our example. That extra $480 in annual rent is $40 a month that a family has to squeeze from somewhere. They feel the pinch.    

The Change Changed

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November 13, 2022

by Stephen Stofka

October’s CPI report released this week indicated an annual inflation of 7.7%, down from the previous month. Investors took that as a sign that the economy is responding to higher interest rates. In the hope that the Fed can ease up on future rate increases, the market jumped 5.5% on Thursday. Last week I wrote about the change in the inflation rate. This week I’ll look at periods when the inflation rate of several key items abruptly reverses.

Food and energy purchases are fairly resistant to price changes. Economists at the Bureau of Labor Statistics (BLS) construct a separate “core” CPI index that includes only those spending categories that do respond to changing prices. It is odd that a core price index should exclude two categories, food and energy, that are core items of household budgets.

Ed Bennion and other researchers (2022) at the BLS just published an analysis of inflationary trends over several decades. Below is a chart of the annual change in energy prices. Except for the 1973-74 oil shock, a large change in energy prices led to a recession which caused a big negative change in energy prices.

We spend less of our income on food than we did decades ago so higher food prices have a more gradual effect, squeezing budgets tight. Lower income families really feel the bite because they spend a higher proportion of their income on food. In the graph below a series of high food price inflation often precedes a recession. Unlike energy prices, there is rarely a fall in food prices. Following the 2008 financial crisis, food prices fell ½% in 2009. It is an indication of the economic shock of that time.

Let me put up a chart of the headline CPI (blue line) that includes food and energy and the core inflation index (red line) which does not. Just once in 75 years, during the high inflation of the 1970s, the two indexes closely matched each other. Following the 1982-83 recession, the core CPI has outrun the headline CPI.

A big component of both measures of inflation is housing. The Federal Reserve (2022) publishes a series of home listing prices calculated per square foot using Realtor.com data. You can click on the name of a city and see its graph of square foot prices for the past year. You can select several cities, then click the “Add to Graph” button below the page title and FRED will load the graph for you. Here’s a comparison of Denver and Portland. They have similar costs.

The pandemic touched off a sharp rise in house prices in both cities. Denver residents have attributed the big change to an influx of people from other areas. However, Census Bureau data shows that the Denver metro area lost a few thousand people from July 2020 to July 2021 (Denver Gazette, 2022). In the decade after the financial crisis, there simply wasn’t enough housing built for the adults that were already here.

The surge in home buying has not been in population but in demographics. As people approach the age of 30, they become more interested in and capable of buying a home. The pandemic helped boost home buying because interest rates plunged from 5% in 2018 to 2.6% in 2021.

Record low interest rates enabled Millennials in their 20s and 30s to buy a lot more home with their mortgage payment. That leverage caused housing prices to rise. A 30-year mortgage of $320K has a monthly mortgage payment of $1349 at 3%. At 5%, it is $1718 and at 7% it rises to $2129. Ouch!

Rising rental costs and home prices drive lower income families to less expensive areas in a metro area or entirely out of an area. Declining public school enrollment has forced two Denver area counties to announce the closing of 26 schools and transfer them to other schools (Seaman, 2022). As the number of students decreases, the schools infrastructure costs do not change, increasing the per student costs. Buses have to be maintained, drivers paid, schools staffed with guards, cafeteria staff, janitors and administrative personnel. Once schools are shuttered, the building may be sold and converted to other uses, either residential or commercial. The public schooling system is like a large ship that takes some time to change course.

During our lifetimes we experience many changes. They can happen quickly or emerge over time. The effects may be short lived or last decades. Families are still living with the consequences of the financial crisis fourteen years ago. Carelessly planned urban development isolates the residents of a community. The social and economic effects can last several generations. As we grow older, we learn to appreciate William Faulkner’s line, “The past is never dead. It’s not even past.”

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Photo by Davies Designs Studio on Unsplash

Bennion, E., Bergqvist, T., Camp, K. M., Kowal, J., & Mead, D. (2022, October). Why inflation matters. U.S. Bureau of Labor Statistics. Retrieved November 11, 2022, from https://www.bls.gov/opub/btn/volume-11/exploring-price-increases-in-2021-and-previous-periods-of-inflation.htm

Denver Gazette. (2022, March 25). Denver joins big city trend with pandemic population slip. Denver Gazette. Retrieved November 11, 2022, from https://denvergazette.com/news/local/denver-joins-big-city-trend-with-pandemic-population-slip/article_65c6393d-2a4d-5b91-837c-f8c3efce3778.html

Federal Reserve. (2022). Median listing price per square feet:Metropolitan Areas. FRED. Retrieved November 11, 2022, from https://fred.stlouisfed.org/release/tables?eid=1138280&rid=462

Seaman, J. (2022, November 10). Schools targeted for closure in Denver, Jeffco have disproportionately high numbers of students of color, data shows. The Denver Post. Retrieved November 11, 2022, from https://www.denverpost.com/2022/11/10/dps-jeffco-school-closures-students-of-color/

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Housing Affordability

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August 14, 2022

by Stephen Stofka

The National Association of Realtors (2022) publishes a Housing Affordability Index (HAI) that measures median housing prices, mortgage rates and median family income to determine a ratio of housing costs to family income. June’s index was the lowest affordability since 1989. Since the Fed began raising rates this year, affordability has fallen by a third. In the notes I’ll include some comments on the methodology behind the HAI.

With technological progress, we expand our definition of what is a necessity. We argue whether government has a responsibility to ensure that each family has a certain level of sustenance – adequate housing, food, a source of income and access to educational resources. Those in neighborhoods with single family homes resist efforts to build affordable multi-family housing. A real estate developer earns a higher profit building expensive townhomes than affordable housing units. Should a developer be compensated if required to build affordable housing? City councils would prefer not to bring up the subject of using tax money to compensate a developer for doing less.

We disagree about who should pay, who should get and how much. Several decades ago, the homeless were less visible, a huddle of a human being lying under a tree or on a park bench, occupying about 18 square feet. In destination cities like Denver, Portland, L.A and other western states, encampments of homeless in colorful pop-up tents line downtown sidewalks and along streams and rivers that course through the town. Depending on the size of the tent each person may occupy up to 50 square feet. Like the rest of us, they are taking up more space per person. Are there more homeless or are they simply more visible?

The reasons why people are homeless are numerous and varied but the dynamics of housing supply and demand are key factors. Where demand for rental housing is low, landlords of affordable units may skip a criminal background or credit check. When demand is high, rents are higher and landlords are more discriminating. They may require higher security deposits as a tool to screen out renters. The annual change in rental costs was 6.3%, below the 7.3% increase in housing costs but workers’ wage increases have not kept pace in the past year. (I’ll put the series identifiers and index numbers in the notes at the end). Over a long time period, have earnings kept up with housing costs?

I began with 1973, the year that the U.S. and most of the world adopted floating exchange rates between currencies. This allowed capital more freedom to move around the world. Several economists mark that as a turning point when the returns to labor began to lag behind the returns to capital. Today’s workers make $612 for every $100 that workers made in 1973, a 6:1 ratio. Housing costs have risen even faster. The Bureau of Labor Statistics calculates that a person spends $888 for shelter today for each $100 spent in 1973. In computing the CPI, the Bureau of Labor Statistics (2022) and the Census Bureau include mortgage payments, taxes and insurance – PITI – to determine the cost of shelter itself (32% of income), about 5% for utilities and another 5% for maintenance and repairs. Together they make up more than 40% of a family’s income.

We measure things in order to compare qualities. An example might be measuring the width of a bookcase and the width of a space in the living room where we want to put the bookcase. Comparing total housing costs across five decades is difficult. We prefer to live in bigger spaces and in far greater comfort than we did 50 years ago. Today’s new homes average 2600 SF. The thirty year average is 1800 SF. Moura et al (2015) estimated that each of us has twice the space of a person living in 1900. Total housing costs may have grown almost 50% faster than wages but per capita housing space has grown at least as much. Adjusting for the larger personal space, we could conclude that wages have kept up with total housing costs. But that’s not how many of us perceive affordability. More space and comfort has become our standard.

Changing standards and expectations cause a shift in definitions and benchmarks. The BLS includes the cost of cell phones, computers and internet access under Information and Information Processing. Many families consider these to be utility expenses as necessary as the heating and electric bill. The BLS estimates a family spends 3.5% of their income on these modern day necessities – about $3000 a year. TV cable subscriptions add another 1%. Five decades ago, a family had a $0 monthly cost for these. Together that cost represents $320 per month that impacts housing affordability. The cars we drive today are safer, more mechanically reliable and more fuel efficient but we spend more of our income on transportation costs. In the post-war period, food and clothing were almost half of a typical family’s expenses. Today those items make up just 13% of a family’s spending (BLS, 2014). We live in bigger homes because other items that used to take up a lot of space in our budget have shrunk.

News media often puts current economic measures in historical context – the highest since and the lowest since – but these quantitative measures are not adjusted for improvements in the qualities of goods. On a hot summer’s day five decades ago, there might have been several overheated cars on the drive home from work. Changing a flat tire on the side of the road was common. Automobile deaths were far higher. Older people died from heat exhaustion in uncooled apartments and homes. Our standards and expectations have changed.

Each month economists measure thousands of data points – as numerous as the stars in the night sky. Economists and politicians connect those dots using different paths of reasoning, motivation and perspective. We may cling to a particular doctrine that clouds our interpretation of the data. In the end economic issues are personal. Have our earnings kept up with our housing costs?

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Photo by Tierra Mallorca on Unsplash

BLS. (2014, April). One Hundred Years of price change: The consumer price index and the American Inflation Experience : Monthly labor review. U.S. Bureau of Labor Statistics. Retrieved August 12, 2022, from https://www.bls.gov/opub/mlr/2014/article/one-hundred-years-of-price-change-the-consumer-price-index-and-the-american-inflation-experience.htm

BLS. (2022, February 11). Relative importance of components in the Consumer Price Indexes: U.S. city average, December 2021. U.S. Bureau of Labor Statistics. Retrieved June 17, 2022, from https://www.bls.gov/cpi/tables/relative-importance/2021.htm

Lautz, J. (2022, January 7). Tackling home financing and down payment misconceptions. http://www.nar.realtor. Retrieved August 12, 2022, from https://www.nar.realtor/blogs/economists-outlook/tackling-home-financing-and-down-payment-misconceptions

Moura, M. C., Smith, S. J., & Belzer, D. B. (2015). 120 years of U.S. residential housing stock and floor space. PLOS ONE, 10(8). https://doi.org/10.1371/journal.pone.0134135

National Association of Realtors (2022). Housing affordability index. http://www.nar.realtor. Retrieved August 12, 2022, from https://www.nar.realtor/research-and-statistics/housing-statistics/housing-affordability-index. As constructed, an affordability index of 100 should be affordable. However, the NAR calculates a mortgage payment that is not typical. They base their calculation on a 20% down payment. The average down payment is only 10%. First time buyers typically put down only 7% (Lautz, 2022). This raises the mortgage payment and lowers the affordability. After adjusting for this, an HAI reading of 140 is probably a better benchmark of affordability.

 U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Housing in U.S. City Average [CPIHOSSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIHOSSL, August 13, 2022. July’s annualized increase was 7.3% and climbing.

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Rent of Primary Residence in U.S. City Average [CUUR0000SEHA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CUUR0000SEHA, August 13, 2022. July’s annualized increase was 6.3% and climbing.

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Shelter in U.S. City Average [CUSR0000SAH1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CUSR0000SAH1, August 12, 2022. Note: Total cost of shelter was 39.90 in April 1973 and in 2022 it is 354.45, an 8.88 ratio.

U.S. Bureau of Labor Statistics, Average Weekly Earnings of Production and Nonsupervisory Employees, Total Private [CES0500000030], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CES0500000030, August 12, 2022. In July 1973 the index was 153.14. In July 2022 937.38. A 6.12 ratio.

Thirty Year Horizon

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April 10, 2022

by Stephen Stofka

In the period leading up to the financial crisis a speculative fever engaged many of the actors in the housing market. This included homebuyers, agents, mortgage brokers, investment firms and risk managers convinced that housing prices could only rise. Homebuyers, struck by FOMO fever, jumped into the home lottery, gambling on a quick flip for a profitable gain with little investment. The frenzy of this market is marked by an opposite phenomenon. Small investors with a portfolio of ten or fewer houses are outbidding conventional buyers with all cash offers. Investment capital is at war with consumption capital.

The Atlanta branch of the Federal Reserve (2022) maintains a Home Ownership Affordability Monitor (HOAM) that ranks the affordability of a home at current prices and interest rates in cities and counties through the country. Readers can select the city, county they are interested in and they’ll see the affordability index. Hover over a county on the map and they’ll see the median home price, median household income and the share of income a house payment would be. The mortgage payment is based on the 3.6% interest rate of two months ago. After the recent rise in interest rates, you can add on at least $200 or more to the monthly payment.

A total housing cost of up to 30% of gross income is considered affordable according to the HOAM guidelines. A rule of thumb to calculate an affordable housing budget is to divide annual gross income by 40. For instance, $80,000 / 40 = $2000 per month. An index above 100 is affordable. The metro Denver area is in the 70s. With an index below 50, a typical household in the LA area would spend more than 50% of their gross income on housing. Some of the counties in the Dallas-Ft. Worth, Texas area and most of the counties in the Atlanta, Georgia area are affordable and that helps explain a growing population in some southern states.

Few will be surprised to learn that housing prices in many cities are unaffordable. Since the housing crisis, not enough housing has been built and low interest rates have increased the pool of qualified buyers. The higher demand puts upward pressure on prices. Older homeowners on a reduced income may resist selling because they cannot find a suitable replacement – a paradox of rising home prices.

In the chart below I’ve added on the Fed’s 2% inflation target to real GDP growth as a benchmark for the 30-year mortgage rate. Rates have been low the past decade but GDP growth has been low as well.

The red line is real economic growth after inflation + 2%. In the last quarter of 2021, economic growth was just 5% above the same quarter of 2019. That two year growth rate is moderate but not strong. The one year growth rate of 5.5% is due to what economists call base effects. Because of the pandemic the 2020 base number was weak, making moderate growth look stronger than it is.

The Fed is expecting growth to average 2.75% this year and decline to 2.3% in 2023 (FRED Series GDPC1CTM). Add in the Fed’s 2% inflation target as I done and the 30 year rate should find a balance in the range of 4.5-5.0%. However, that rate will probably overshoot before finding an equilibrium. The war in Ukraine will make it more difficult for that balance to happen. Homebuyers should not expect 30-year rates to fall below 4% in the near term.

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Photo by Laib Khaled on Unsplash

Federal Reserve. (2022). Home Ownership Affordability Monitor. Federal Reserve Bank of Atlanta. Retrieved April 7, 2022, from https://www.atlantafed.org/center-for-housing-and-policy/data-and-tools/home-ownership-affordability-monitor Link updated 2/23/2025 → https://www.atlantafed.org/research/data-and-tools/home-ownership-affordability-monitor#Tab2

Home, Sweet Home

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April 3, 2022

by Stephen Stofka

Interest rates belong to the world of money assets where changes can happen as fast as a keystroke. Prices are “sticky,” moving slower in the concrete world of real goods and services. This week the 30-year mortgage rate rose to 4.67% (MORTGAGE30US), but home prices are still high, reflecting the higher demand for homes at low interest rates. Denver was 11th in the country with an annual price increase of more than 20%, according to the Case Shiller index for January (DNXRSA see note). Six months ago, a 30-year rate was 2.87%, near a historic low. The difference in monthly payments on a 30-year $240K mortgage is $245.

When we buy a home, we leverage our down payment into a stable asset and become our own landlord. When the BLS computes the CPI inflation index, they include an item called Owner Equivalent Rent (OER) and it contributes 25% to the CPI index, the largest component of that index. Based on a survey of actual rental housing, OER represents the opportunity cost of renting our home to ourselves rather than to someone else at the going market price. While this might seem contorted, it reminds us that a home represents consumption capital, an investment whose benefits we consume during the time we own the asset. A home is the largest component of most household wealth.

The Federal Reserve charts changes various components of household wealth (Fed, 2022). Our homes represent a stable base of change, as the chart below shows.

The light green shaded area is the change in our home equity. You can visit the site and play with the time controls. Because the change is so stable, people’s expectations became anchored until the housing and financial crisis when the change in housing equity turned negative. People were shocked that such a thing could happen on a broad national scale. It is not unusual for home prices to turn down in a local area, usually in response to a substantial shift in the economic base of an area. Home prices in some Midwest cities experienced substantial losses as manufacturing went to other countries with lower labor costs. In the 1980s, the decline in oil prices made investments in oil shale on Colorado’s western slope unprofitable. Thousands lost their jobs and the prices of working class homes in Denver experienced a 10% decline (DNXRLTSA). Over several decades across the entire country, home prices are sure to rise but the probability of regional economic declines is equally sure.

The blue bars in the graph above represent the volatile changes in stock market equity. Compare that volatility to the stable changes in bond equity (orange). That’s why financial advisors recommend a growing portfolio allocation to bonds as we grow older. The small deviations in bond and real estate prices help anchor the large deviations in stock market wealth.

As mortgage rates rise, people can afford less home and the decrease in demand should relieve the upward momentum of rising home prices. There are those who play momentum in stock prices, buying and selling to take advantage of short term changes in sentiment. The graph above highlights the difference in deviations of stocks and homes. Playing the real estate market like it was the stock market got a lot of people in trouble during the 2000s. A home is an investment in stability, not a raffle ticket to riches.

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Photo by Scott Webb on Unsplash

Home Price, Denver Note: Even affordable homes in Denver have experienced sharp prices increases, rising 19.6% in January (DNXRLTSA).

Fed. (2022, March 10). Board of governors of the Federal Reserve System. The Fed – Chart: Changes in Net Worth: Households and Nonprofit Organizations, 1952 – 2021. Retrieved April 2, 2022, from https://www.federalreserve.gov/releases/z1/dataviz/z1/changes_in_net_worth/chart/

Life Choices

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September 19, 2021

by Steve Stofka

Economics is built on the principle of the rational person capable of making a choice between two options. In casual conversation we use the word “rational” to mean making sense but in economics it means making a choice. The choices presented may have constraints that make the word “choice” seem inappropriate. Does an addict have a choice? Yes. Sometimes we steer our lives with a critical choice of more or no more, having to choose between an unbearable more and a no more that contains an equally unbearable number of unknowns.

We might leave a job with only the hope that we can find another one soon. We may cast a no more vote, rejecting an incumbent for an unknown candidate. People living in the path of a hurricane or forest fire must make the difficult choice of evacuating the area or staying in their home and hoping they will be safe. Making a no more choice with family relationships can twist a person’s mind and soul in knots. A battered women may endure more until they reach the point of no more and leave their situation.  

As the Delta variant of Covid-19 sweeps through the population, many people are making difficult life choices about their jobs. In March 2020, the number of job openings plunged more than a third from 7 million to 4.6 million. In January this year, openings regained their pre-Covid levels and have risen quickly since then. The July report indicated almost 11 million openings, a series record.

After adjusting to online work, some workers have made that a critical preference. They have said no more to long commutes. Some have moved from dense urban areas to less populated states like Montana where rents or house prices will not consume half a paycheck. They have said no more. The sudden job loss last year caused some workers to rethink their priorities and career choice. The lack of affordable childcare has been a deciding factor for some workers.  

In economics, utility theory explores a choice between quantities of two goods. For example, will I have more pizza or more ice cream? These simple unrealistic examples help a student practice the concepts but are not suitable for no more life choices. Because these decisions act like switches, their calculations are hard to model. We may be able to bargain with our company who wants workers back in the office. Many times, we have to make a hard choice, one that can’t be undone.

We may revisit difficult choices, trying to understand and refine our decision making process. Many younger workers will look back and see this as a defining moment in their life. Some will wonder what if, replaying their choice. In a period of five years, our grandparents and great-grandparents endured rationing during WW1, followed by the Spanish flu that killed thousands, then the severe recession of 1921. Life narrowed their choices and they endured. By the time a person reaches their 80s, they have decided on more about 30,000 days. We remember the no more decisions more than we remember the many decisions of more. Each day is a crossroad.

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Photo by Einar Storsul on Unsplash