Affordability Indices and the Housing Crisis

By Paul and Kim Thomas

Housing affordability has long been an issue in many parts of the United States, but it has become especially compelling in California in recent years. The New York Times described the California situation as “The Cost of a Hot Economy: A Severe Housing Crisis.” (Adam Nagourney and Conor Dougherty, New York Times, July 17, 2017).

With reports of growing inequality of income and rapidly rising housing prices and rents, it is only natural to worry about the difficulty that low income households in particular might be having in finding decent housing they can afford. Such worries have recently led the California State Legislature to act. In September of 2017 they passed a package of 15 bills designed to address the problem of affordable housing, which Assemblyman David Chiu, D-San Francisco, called “the most intense housing crisis that California has experienced in our state’s history.” (Murphy, Katy, “Affordable housing crisis: Can Sacramento get it under control?”, Mercury News , Sept. 5, 2017).

This article will discuss the purposes and limitations of two indices of affordability that have played prominent roles in housing policy discussions all across the U.S. in recent years. They include a home purchase affordability index produced by the National Association of Realtors (NAR) and a rental affordability index (RAI) produced by the U.S. Department of Housing and Urban Development. Both indices have similar purposes, namely to indicate how easy or difficult it is for a typical household to pay for a typical housing unit.

The NAR index uses a calculation of the monthly income needed to buy the median house in the market under consideration, assuming a 20% down payment and a standard mortgage. The NAR defines a house as “affordable” to a given household, if that household can cover the monthly mortgage payment with 25% of its monthly income or less. The NAR index compares the mortgage payment that the median household can afford to the mortgage payment required to buy the median house. If the median household can just afford the median house, then the index for that population of households and houses is 100. If the median household has more income then needed, say 30% more, then the NAR index for the entire population is 130. If the median household has only 90% of the required income, then the NAR index for the population is 90.

The RAI is similar to the NAR index, except that a rental unit is defined as “affordable” for a renter household, if the household can cover the monthly rent with 30% of its monthly income or less. Like the NAR index, the RAI will equal 100, if the median household can just afford the median-priced house and will be greater than 100, if the median household would have money left over after paying the rent on the median-priced house.

The graph below shows the NAR index for the U.S. market from 1971 to 2017. The gray bars indicate recessions and the white areas periods of GDP growth. Affordability has been above 150 for the last 7 years, indicating the median household was more than able to afford the median house for sale during that period. Overall, this graph does not seem to suggest any particular reason to be alarmed about affordability in home purchases.

What about rental affordability? After all, most (56%) households in the bottom income quartile are renters. The chart below from the Department of Housing and Urban Development ( shows that the RAI has remained above 100 over the entire period 2001–2016, indicating that the median renter has had more than enough income to lease the median rental unit during these years. The index declined 14% on net between 2001 and 2016, but since its last steep decline in 2010, it has generally been rising. Where, then, is the current affordability problem?

To answer that question definitively, we would have to look at the various factors that shape the housing purchase and rental markets in the U.S. Here we will discuss only the contribution of one important factor, namely the interest rate for mortgage loans. In the calculation of household income needed to purchase a house used in the NAR index, interest rates have a dramatic effect on required monthly payments. For instance, a 30 year fixed mortgage on a $200,000 loan (a fairly typical mortgage for a $250,000 house after a 20% down payment) costs $844 a month with a 3% mortgage rate and $1200 with a 6% rate. The following chart shows that interest rates have been quite low recently ever since the Great Recession of 2008, far below the rates that accompanied the very tight monetary policy of the early 1980’s. This would certainly help to explain why owner-occupied housing has remained affordable since 2008.

Commercial and industrial loan rates, which have followed a similar pattern, should also have made it more attractive for developers to build new homes and apartment buildings, which should have increased rental affordability, all other things remaining the same.

In fact, construction did increase significantly over the past decade. Between 2005 and 2015, as the number of households renting increased by 9 million, the rental stock increased by 8.2 Million units. However, only 10% of newly constructed units had rents under $850 per month, the level the median renter could afford with 30% of income. The number of low-cost rental units increased by only 10% as the number of low-income households increased by 40%. The gain in moderately priced units was only 12%, while the increase in moderate-income households competing for them was 31%. It is hardly surprising that rents in those low-to-moderately-price markets rose rapidly. To exacerbate the problem, filtering down of higher-value housing to lower priced markets — usually the largest single source of additions to the lower-priced housing stock — also slowed as an influx of new renters at high incomes occurred. The increase in demand at the high end made it worthwhile to maintain or upgrade existing stock to keep it competitive in that high end of the market. (Harvard Joint Center for Housing Studies 2015 edition of “America’s Rental Housing”.)

In a recent working paper, Bieri and Dawkins (“Amenities, Affordability, and Housing Vouchers” at explain further why affordability has differed for different income classes of renters in different areas over recent years. For 2/3 of metropolitan areas, rental housing has become more affordable for a person of median income, because median income has grown faster than median rent in those areas. But for the 1/3 of renters in coastal metropolitan areas like LA, San Francisco and San Jose, median rent has been climbing faster than median income. This has occurred in part because of the shift among many affluent households from buying to renting following the 2008 Great Recession, which has put upward pressure on rents in areas where land and other construction costs were already high. As we might have expected, it has been the lowest income buyers and renters who have found it hardest to adjust to these price increases. (Harvard Joint Center for Housing Studies, 2015 edition of “America’s Rental Housing.”)

There are additional complications on the supply side of housing that we will only mention briefly here. These include especially the effects of local permitting, zoning, environmental and anti-growth regulations. All of these tend to keep construction costs high and restrict the supply of new housing in affected areas. Higher construction costs tend to make it less profitable to build any kind of housing, but are most likely to make supply of lower-end rental units unprofitable, particularly with density or location restrictions that do not constrain other types of development. If demand increases for high-end units, as it has since 2009 across the US, the filtering of older, high-end housing downward into the stock of lower-priced housing will also slow down and contribute to an even more brutally tight supply at the lower end of the market.

Both indices discussed above could in theory be adjusted to include normal expenses associated with housing purchase or rent that would affect the overall affordability of a particular housing unit. These might include utilities, insurance, taxes, or transportation costs to a workplace. Researchers at Chicago’s Center for Neighborhood Technology have attempted to correct for transportation costs in their analyses.

It has also been suggested that levels of local amenities should be included in evaluating affordability. (Bieri and Dawkins, op. cit.) This could be particularly important when government subsidies for individual households are being considered.

Policy-makers should be aware that simple indices such as the NAR and RAI are not capable of revealing all we need to know about affordability in housing markets to create good public policy. As we consider various alternative plans for helping our most vulnerable citizens, we must supplement our use of simple indexes with more detailed information about local housing markets and the people they serve.

Paul and Kim Thomas are Co-Founders and Principals in Economic Stories LLC, a firm that they developed in Port Townsend, Washington. The opinions in this article are presented in the spirit of spurring discussion and reflect those of the author and not necessarily the treasurer, his office or the State of California. Information and data used in this article was compiled by the authors and is not meant to be used as an official State of California source or replace official information released by the State of California and/or State Department of Finance.