Morning Report: House prices hit new highs. Are we in a bubble?

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10 Year Govt Bond Yield	2.28%
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30 Year Fixed Rate Mortgage	3.95

Stocks are higher this morning as the Fed begins their 2 day FOMC meeting. Bonds and MBS are down. 

House prices rose 0.4% MOM in May, according to the FHFA House Price Index. They are up 6.9% YOY. Home price appreciation is still red-hot on the West Coast, however some of the laggards (Midwest and East Coast) are starting to pick up steam. Meanwhile, the Case-Shiller Home Price Index rose .1% in May and is up 5.7% YOY. Why the difference? The FHFA House Price index only looks at homes with a conforming mortgage, which eliminates the distressed all-cash extremes on the low end, and jumbos on the high end. Certainly out here in the Northeast, the luxury end of the market (aside from trophy properties in the Hamptons and Manhattan) is deader than Elvis. Note that we have more than recouped the losses from the go-go days, at least according to the FHFA House Price Index.

I wanted to spend a little more time discussing housing affordability. If you look at the median house price to median income ratio, we are approaching the highs during the bubble years. We are currently at around 4.4x and historically, that number has been between 3.2 and 3.6x, meaning that house prices are stretched compared to incomes. It makes sense that house prices should be related to incomes in terms of measuring affordability, and also vulnerability do downdrafts. 

However is "median house price" the correct metric to use when determining affordability? It has one major flaw: it ignores interest rates. As car dealerships know, the sticker price is not the metric to sell a car: it is the monthly payment. Can't afford a 30,000 car? Well, what if we go from a 6 year loan to an 8 year loan? Can you now afford that payment? Mortgages aren't really that much different. So, to look at it from that angle, I plotted the typical mortgage payment (80 LTV conforming loan) on the median house and calculated what percentage of median income that payment turned out to be. And when you look at it that way, affordability it still pretty decent, at least compared to historical numbers. The reason why? Interest rates. For almost a decade, mortgage rates were double digits, and that equates to a much bigger payment for the same "median house." It turns out that mortgage payments as a percentage of income are much lower than what they historically have been. 

Now, the one complicating factor is the mortgage interest deduction, which makes housing in the 80s look less affordable than it really was. Taxes were higher, and interest as a percentage of the P&I payment was higher, so the differences are somewhat exaggerated. However, it does appear that buying a house is not as "unaffordable" as the median house price to median income ratio implies. Just remember these graphs when you hear people discussing how high real estate prices are and that we are in another bubble. We aren't.