This article was originally written by Doug Short. From 2016-2022, it was improved upon and updated by Jill Mislinski. Starting in January 2023, AP Charts pages will be maintained by Jennifer Nash at Advisor Perspectives/VettaFi.
We continue our real estate research with a study on metropolitan affordability in the rental and mortgage markets. Once again, we tap into Zillow Group’s wealth of data and use a data set that includes mortgage affordability, rental affordability, and price-to-income ratios for the five most populous US cities with a comparison to the national median. Incidentally, those five cities represented 17.5% of the national population in 2015. Zillow data is quarterly from 1979 through the third quarter of this year. Income data is monthly and sourced from the Census Bureau through 2015.
It is no secret that it is more affordable to buy a home than rent - i.e. mortgage payments are typically less than rent payments for a similar unit or home. Mortgage and rental affordability are defined as the percentage of income spent on each, respectively. In this first chart, we compare mortgage affordability with rental affordability since 1979. You’ll notice the percentage of income that renters spend has increased by 20%, whereas the percentage of income owners spend has gone down by 46%, both since 1979. Not surprisingly, mortgage affordability is highly correlated with the 30-year mortgage rate, which explains the large improvement in affordability since the late 1970s.
Let’s look at rental affordability in the top 5 most populous cities over the past 37 years. Notice that renters in Los Angeles spend a whopping 48% of their income on rent and for New Yorkers, that number is 41% of their income on rent.
Here’s the same chart, but using mortgage affordability instead. While it’s still much more expensive to buy in New York or Los Angeles, it’s still cheaper than renting. In Los Angeles, owners spend 39% of their income on their mortgage and for New York, that number is 24%.
The chart below is another look at rental affordability, this time with changes since 1979. Americans spend 20% more on rent today than in 1979, but notice the huge changes for New York and LA: New Yorkers spend almost 50% more of their income on rent today and in LA, they spend 47% more than in 1979.
With renters spending so much of their income on housing, we examine the price-to-income ratio, which is the median home value divided by the median annual income. In the US, a home costs about 3.3 times the median annual income. Per Sentier Research’s household income data, the real median household income for September is $57,821. Sentier Research uses Census Bureau data to publish more timely data, of which we cover in this monthly update.
Looking at this chart, we can see that in Los Angeles, homes cost almost 9 times the median annual income, and in New York, it is 5.5 times the median annual income. The rule of thumb for spending on housing is the 50-30-20 rule: spend 50% of your income on living expenses and essentials, including rent, transportation, groceries, etc., 30% on to “flexible” spending (i.e. non-essentials), and 20% goes to savings. Embedded in the 50% essentials spending is the old 30%-spending-on-housing, which some claim is no longer relevant in today’s market. If we use that 30% marker, then the US price-to-income ratio seems pretty much spot on. For New York or Los Angeles, however, it’s out of control.
Let’s do a quick calculation: for those living in Los Angeles, the cost of a home is 8.9 times the median annual income – using the median household income figure for Los Angeles County (in 2015 dollars, this is $56,196) and multiply it by 8.8 (2015 figure), we arrive at $494,524. To buy that home, a down payment of $98,904 is recommended. For a renter making the median annual income in LA who is trying to save to buy a home is spending 48% of their income on rent – in 2015, that’s $26,974 annually. After taxes (using 2015 as our tax year and married filing jointly), this leaves just over $16,882 a year to pay for other essentials like transportation and groceries, as well as non-essentials and savings. If we take that figure and apply 50-30-20 rule to the cash leftover, that leaves $3,376 annually to save. At that rate, it will take 29 years to save for the down payment.
Of course, this does not consider rising incomes because of job progression nor a plethora of other variables. What is staggering is that for families with one or even two individuals making the median annual income, the cost of living in these large metropolitan areas is much higher and thus there is less left to save.
The cost of housing in cities continues to rise. While cities offer easier access to transportation and job opportunities, it’s still a pricey prospect.
Other real estate articles of interest:
Metropolitan Home Prices and the Zillow Home Value Index
49 Years of Income and Home Values
Read more updates by Jen Nash
