Affordability and Availability

The American housing market finds itself in a place that was unimaginable a decade ago. Reeling from a crisis that originated in a housing market that saw too many buyers own homes they could not afford, and lost to foreclosure, Americans were more wary of home ownership and lenders were forced to create conditions that kept demand constrained. An overhang of several million unsold homes led to steep declines in property values. Home price inflation was not front of mind.

After a decade of underbuilding and low interest rates, America’s housing market has turned 180 degrees, from excess inventory to record shortages of homes for sale, from plunging property values to record price appreciation. The housing market is far healthier in 2023 than it was in 2009, but the problems that exist have slowed the market almost as dramatically.

Most homeowners do not view above-average price appreciation as a problem. Their investment – often the single biggest investment they will make – pays off when prices go up. For people who want to buy a home for the first time, unusually high appreciation is a barrier to purchasing that keeps getting higher. Over the past few years, as inflation ratcheted up and the inventory of homes for sale plummeted to record low levels, the price of homes surged at double-digit rates. That prevented many renters who had saved to buy a home from doing so.

When the Federal Reserve Bank began aggressively raising interest rates to combat higher inflation in March 2022, it was a double whammy for many would-be buyers and sellers. The additional borrowing costs of mortgages that were three or four percentage points higher than a year earlier became another barrier to purchasing. For existing homeowners interested in selling, the thought of trading a three percent mortgage for one that was double that rate was chilling.

As jarring as the home price inflation and rising mortgage rates were, the problem of affordability in the U.S. housing market began well before the COVID-19 pandemic that drove inflation and interest rates up. The demand for home ownership has outstripped the supply of existing homes for sale for nearly a decade. If the pandemic had not happened, prices would likely be lower than they are today, but it is unlikely that many more buyers would be able to afford a home.

The solutions to the problem are obvious, and also quite difficult to achieve. As is often the case, the government can be part of the solution, but mainly if it pulls back and allows the marketplace to work. Homebuilders are champing at the bit to build more houses, which would relieve the supply problem. However, there are not enough lots, nor enough workers, to make that happen. People are working hard to make home ownership more affordable, but it is going to take time for the solutions to be effective.

Affordability or Availability?

Housing is less affordable now than it has been since before World War II. At least that is the headline story about the U.S. housing market. By most measures, the cost of a home is higher than at any time in the nation’s history. That is a trend that has been exaggerated since the start of the pandemic but has less to do with a virus than with long-term supply constraints.

Affordability is about more than cost, however. By many measures (home ownership rates key among them), home ownership is as affordable, or at least as attainable, as it has ever been. It may be accurate to say that more people would own homes today if the cost of housing was lower, but the greater problem seems to be the limited supply of houses and housing options to purchase. These two are obviously related concepts; however, with the supply of homes to buy at all-time lows, it is not possible to determine how much higher home ownership would go.

The peak of home ownership in modern U.S. history occurred during what we refer to as the housing bubble of the mid-2010s. Policies of both the Clinton administration and the George W. Bush administration encouraged home ownership by offering incentives to add to both supply and demand. There was an easing of regulations that encouraged more new construction and more demand. The latter was achieved mostly by loosening regulations on residential financing that encouraged more buying. When the bubble popped in 2007, financial chaos followed. Millions of homes entered foreclosure. Home purchases slowed. New construction declined by two-thirds and took almost a decade to recover to equilibrium.

Through all that disruption, the home ownership rate fell five full percentage points, from 69 percent at the peak to 63.4 percent in the first quarter of 2015. But that decline took more than six years to unfold and the trough was at the same home ownership rate as in spring 1994, before the policies that encouraged the bubble were introduced. From all evidence, the peak to trough slide following the housing bubble was largely a function of a slower rate of new home ownership from the Millennial generation. The median sales price fell nearly $50,000 from the peak in 2007 to January 2009, but then grew steadily and was $30,000 more than at the peak of the bubble when home ownership hit bottom in 2015. Conversely, home ownership ticked up nearly five percentage points since 2016, even as the median sales price rocketed higher by 60 percent, or $180,000.

Through all that disruption, the home ownership rate fell five full percentage points, from 69 percent at the peak to 63.4 percent in the first quarter of 2015. But that decline took more than six years to unfold and the trough was at the same home ownership rate as in spring 1994, before the policies that encouraged the bubble were introduced. From all evidence, the peak to trough slide following the housing bubble was largely a function of a slower rate of new home ownership from the Millennial generation. The median sales price fell nearly $50,000 from the peak in 2007 to January 2009, but then grew steadily and was $30,000 more than at the peak of the bubble when home ownership hit bottom in 2015. Conversely, home ownership ticked up nearly five percentage points since 2016, even as the median sales price rocketed higher by 60 percent, or $180,000.

What has changed since that steep run up in prices and the recovery in home ownership has been the cost of borrowing money. The interest rate on a 30-year mortgage has gone from below three percent in November 2021 to 7.5 percent as Labor Day loomed. That is a difference in payment of almost $700 per month on a $240,000 loan.

That delta in monthly payment obviously meant the difference between buying and renting for many. The jump in mortgage rates also had a chilling effect on the supply of homes for sale. By the time the Federal Reserve Bank paused rate hikes earlier this year, the Mortgage Bankers Association (MBA), reported that 82.4 percent of current mortgages are below five percent, and 62 percent are below four percent. Homeowners with low mortgage rates were faced with payment increases that were undesirable, even if affordable.

“As you got closer to six percent, fewer homeowners were willing to switch out of their current mortgages,” says Mike Henry, senior vice president of residential lending for Dollar Bank.

Of course, cooling off the housing market was one of the goals the Fed hoped to achieve when it began aggressively raising rates in March 2022. Home prices began falling at the end of 2022 and dropped by more than $63,000 year-over-year in July 2023. The aggressive tightening has not helped the inventory problem.

The August 22 report on the housing market from the National Association of Realtors showed some small steps in the right direction for supply. New sales slowed, but the inventory of homes for sale was off to a greater degree, 14.6 percent lower than a year earlier. The number of homes for sale did grow from June to July, however, rising 3.7 percent to 1.11 million homes. And the supply of homes for sale edged up from 3.1 month’s supply to 3.3 month’s supply from June to July. In the Greater Pittsburgh market, however, the supply of homes for sale is less than two months’ worth.

“The challenge with the existing home market is that there is not one lever to pull that could take care of everything. It’s a combination of several factors,” says Howard “Hoby” Hanna IV, CEO of Howard Hanna Real Estate. “When you look at our population base, the Baby Boomer cohort is still such a big group and are behaving differently from previous generations. Today’s 75-year-old isn’t the 75-year-old of 40 years ago. They are more active and are willing to maintain their family house. Even those that are interested in downsizing are finding that there is little product to move into.”

For new construction, the supply issue is a shortage of buildable lots. There too, the cause of the problem can be traced to the mortgage crisis. In the aftermath of the financial crisis in 2008, Congress passed the Dodd Frank Act and set up the Consumer Finance Protection Bureau. Among the many new regulations that were placed upon residential finance, constraints on commercial lending also impacted residential development. New housing developments are financed through commercial loans. Certain new conditions, which increased the required equity and diminished the value of long-term land holdings, made residential development less profitable. New land development for housing chilled and in Pittsburgh the effect was worsened by a shortage of lots that existed before 2009.

In the decade or so since Dodd Frank became law, some of those regulations have been eased or erased. But land prices appreciated at a more rapid rate in the interim and environmental regulations increased. The risk of new development is higher than it was in 2009. With higher interest rates squeezing margins, new development is even slower now, despite the perceived higher demand.

Builders that do not develop their own properties – the vast majority of builders in Western PA – have responded to the lot shortage by starting fewer, more expensive homes.

Creating Availability and Affordability

The remedy for new construction is more available land for development. In Pittsburgh, as in most older cities, that means more density of development, since available land is limited. In suburban areas, the obstacle to more density is municipal zoning and a lack of community support. In the most popular and growing parts of metro Pittsburgh, municipalities have revised zoning ordinances to reduce density over the past 20 years. Many have also created overlay districts that allow for planned developments that include apartments or townhomes, but new projects frequently face opposition from residents.

The opportunity for a significant increase in development is greater in the urban center of the region. While the population of the City of Pittsburgh has not grown, the demographic changes – the median age of a Pittsburgh resident is more than 10 years younger than a county resident – suggest that many more young people are moving to the city than the suburbs. Pittsburgh established a land bank in 2014 to take advantage of this trend and create more buildable property. That land bank has been ineffective.

Pittsburgh’s governing council took a remarkable step on August 22 when it passed new legislation that enables the ineffective land bank to sell abandoned properties to developers and community groups. The new legislation allows for hundreds of vacant parcels and condemned buildings to be sold, clearing out administrative hurdles that had obstructed sales to potential owners seeking to bring new investment to under-invested neighborhoods. The move was applauded by the leaders of community groups like Bloomfield Garfield Corporation and East Liberty Development Inc., which have had successes in redeveloping troubled neighborhoods without enabling legislation.

The change does not necessarily assuage concerns about the land bank. Nine years after it was established, the land bank had failed to close on any properties until earlier this year and has only five sales to its credit. The legislation that passed on August 22 came only after significant council infighting about the role it would play in the land bank’s operations. With clearer direction from council, the city’s land bank has a pipeline of properties and $3.5 million in stimulus funds to begin acquiring and re-selling some of the roughly 5,000 properties that the City of Pittsburgh currently owns.

In the best-case scenario, a significant portion of those properties will be sold to developers of multi-family (apartment) projects. Given the constraints on single-family development, construction of new apartments can relieve the shortage of housing more quickly than a surge in single-family development.

An annual study that is done by underscores how effective multi-family development can be in remedying the housing shortage. tracks the number of household formations and housing starts that the Census Bureau reports each year. In its report on the market in 2022, issued earlier this year, calculated that there was a 6.5-million-unit shortfall in the number of single-family homes needed to meet the demand from the 15.6 million household formations from the prior decade. If multi-family starts are included, however, the gap falls to 2.3 million homes.

The lead time needed to complete and stabilize a 300-unit apartment in Pittsburgh is roughly three years, from concept to lease-up. To complete a similar sized single-family development, of which there are few, it may be twice as long, often longer. The quicker route to meeting demand is through more multi-family development, a solution that the private sector seems to grasp. As of Labor Day, it is projected that more than 8,100 multi-family units have begun or navigated the entitlement process. That number represents new construction only, not adaptive re-use and does not include projects that have been announced but have not begun entitlement. Nor does the total include numerous projects that have less than 100 units, such as Presbyterian Seniorcare’s 80-unit Oakland Gateway project or Hardy World’s proposed 66-unit apartment at 1801 Boulevard of Allies.

Based upon historical performance, there is usually two-to-three years supply of projects in the pipeline at any given moment. Typically, the number of units in the pipeline work as a reasonably accurate forecast for the coming two years. That rule of thumb suggests that at least 3,500 new apartments will be built in 2024 and 2025, an increase of 63 percent over the total new units built in 2021-2022, and 30.5 percent more than were built in 2013-2014, the two most active years of the 2010s apartment “boom.”

That pipeline is encouraging; however, it is likely that several thousand of those units would already be under construction were the financing conditions different. The elevated interest rate environment has wreaked havoc upon apartment development too. Higher rates have changed the calculus for investment in multi-family. As borrowing costs have risen, the projected net operating income for the property has fallen, and the value of the project with it. In the months since the Silicon Valley Bank failure in March 2023, lenders have increased their emphasis on debt service coverage and tightened up estimates of rental income. Construction costs are higher and average rents have hit a plateau or fallen. These are not the ingredients for an apartment development boom.

Nick Matt, senior managing director and Pittsburgh office co-head, JLL Capital Markets, says that virtually all deals his firm has done have been situations that had to be addressed, like loans that have matured or forced sales. Asked what would make financing an apartment deal work, Matt says, “The developer, and the people that believe in the developer, can come up with 35 percent cash. With that, we can get the shovel in the ground. But that’s the disconnect right now.”

“The primary issue is rates. Construction costs are elevated, and rents are what they are, even though we have a vibrant apartment market. Lenders don’t care what the appraised value is right now; they care about debt service coverage,” he continues. “The bank we’re dealing with on one deal that is going forward is using a seven percent permanent rate and 25-year amortization and they want to be around 120 percent debt coverage. If you do that math, you come out to 60 or 65 percent loan-to-value. They are backing into the loan to value from the debt coverage, not the appraisal.”

“The only deals getting done are those that have to get done, that are maturing. Even those are very difficult to make work,” says Dan Puntil, senior vice president at Colliers Mortgage.

Puntil explains that the reliable lenders for multi-family remained bullish on the market, even after the full run up in rates. The liquidity crisis in March and the downgrading of the U.S. bond rating in early August have changed that.

“Fannie and Freddie are still in the market. They never leave,” Puntil says. “But several of the life insurance companies are on the sidelines for now.”

Even with the challenges facing the marketplace, there are developers trying to get underway. In recent weeks, contractors have been taking bids for several of the projects proposed, hoping to get pricing that meets the new expectations of the market. Oxford Development has been moving forward with a different model for the 242-unit apartment building it is proposing for the second phase of 3 Crossings in the Strip District. Oxford has stripped out some of the amenity spaces that have come to be included in apartment projects, counting on the stand-alone amenities of the surrounding 3 Crossings neighborhood to suffice for residents so that they can offer new construction at rents that are 10 or 15 percent lower than the market.

“We’re in design development now. I think the schedule for us to have completed permit set by November or December,” says Michael Barnard, vice president of development for Oxford Development. “We had a presentation for Strip District Neighbors and got a great response and a letter of support. This is unique in that it’s effectively part of a master development plan. It should be a little easier to get approvals.”

Other developers have been less fortunate with community representatives. Walnut Capital’s Oakland Crossings project, which will bring 426 units of workforce housing to undersupplied Oakland, spent more than two years sparring with the city and Oakland Planning and Development Corporation to get its plans approved. And Barnard admits that the 3 Crossings project will likely face hurdles with the city since the building will be on the riverfront.

Removing barriers to development may ultimately be the best solution government can provide. There are billions that have been distributed to cities and states as part of pandemic relief. Some of those funds, like the more than $80 million that have been committed to the City of Pittsburgh by Housing and Urban Development, can go directly to subsidizing housing development for low-income residents. But, in Pittsburgh, the private sector has responded to a shortage in supply by developing more apartments. Much of that development is still in the planning and entitlement stages. Business-friendly government can work to facilitate development, which would bring more competition into the marketplace.

The solutions to the housing shortage and affordability problems will emerge in time, just as the post-Great Recession market was healed. Beyond incentives, new construction will pick up when interest rates recede, and wages and rents catch up to the new normal for pricing (or when pricing moderates). Rate cuts unfortunately do not appear to be in the cards until mid-2024, so the problem is likely to persist for another year. Demand, on the other hand, will persist longer. Until the two are re-balanced, the housing market will be challenging.

“The general consensus is that rates will come down. We’re thinking that within the year, rates will start to come down,” says Henry. “Mortgage rates are not likely to go to three, but people are now used to 6.5 percent. If it becomes 4.5 percent or even 5.5 percent, you’ll see some movement. I think that’s the only thing that will unlock the housing market.”  NH