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California Housing Affordability Index Might Be Flashing Warning Signs

Over the past few months, my South Bay real estate blog has been gushing about the overall strength of our local housing market.

Second quarter data shows buying frenzy! North Redondo new construction price surges! Condo/townhome price growth! And, Valmonte going to all-time highs!

These are topics that I have covered just since the beginning of July. To say the least, it has been an incredible 2021.

And, while home prices are going higher in one of the strongest markets in a generation, there might be some early warning signs that buyers and sellers need to watch carefully.

Although imperfect, in my opinion, the #1 indicator of where the market might go is C.A.R.’s Housing Affordability Index.

Last week’s second quarter release of the housing affordability index got me a little nervous.

C.A.R.’s Housing Affordability Index & Prices

Before I jump into the second quarter numbers, for those not familiar with the blog and past Housing Affordability Index posts, I will do a quick refresher.

C.A.R.’s Housing Affordability Index takes the median priced home in the state of California, along with taking interest rates, costs, etc. and based on income statistics shares how much of the state’s population can afford the current median priced home.

A Housing Affordability Index number of 50 means that 50% of Californians can afford the current median priced home.

Typically, the more Californians that can afford a home, the more room the market has to grow. Conversely, the fewer Californians that can afford a home, the more risk it becomes for price corrections.

For example, past California housing corrections have occurred when the Housing Affordability Index reaches the high teens, oftentimes around 17%. Just before the Great Recession, the Housing Affordability Index reached 11% because of “liar loans” and the creation of one of the largest real estate bubbles ever.

On the flip side, after the Great Recession (2008 – 2012), the Index bumped around in the 40s and 50s. In 2009 and 2011, the Housing Affordability Index hit 55% affordability which proved to be an amazing window to buy. In theory, it called the bottom.

For past blogs on the topic, see below:

California home forecasting experts have stated that although a HAI in the high teens has represented the number to expect price corrections, we could see corrections in the low 20s the next time around. Their main idea is that thanks to tougher underwriting standards, student debt, and childcare costs that were not experienced with previous generations, we will max out on affordability sooner.

In short, if you are a believer in the C.A.R. Housing Affordability Index your loose rules might look like this…

  • Sell when the Housing Affordability Index reaches the teens to very low 20s
  • Buy when the Housing Affordability Index goes above 30

C.A.R.’s Secord Quarter Number is Low

As the market began catching fire during the second half of 2020, we saw Housing Affordability Index numbers that were healthy, but beginning to drop.

  • 2020 Q1 – 35%

  • 2020 Q2 – 33%

  • 2020 Q3 – 28%

  • 2020 Q4 – 27%

  • 2021 Q1 – 27%

  • 2021 Q2 – 23% (last week’s number)

The latest Q2 number is as lowest we have seen in over a decade, the HAI has not gone lower since Q4 of 2008 when the index was at 18%.

Crazy.

My past blogs have covered some mortgage interest rate tantrums where in the summer of 2018, we saw affordability drop to 26% and 27% thanks to rising interest rates. That was a medium-term low.

We have hovered between 26% and 35% since 2018. (Interest rate tantrum low to pandemic stay-at-home high.)

This 23% number is a precipitous drop in a very short period, and an especially shocking drop of four points from last quarter.

What Does it All Mean?

Well, it is always just speculation as no one has a crystal ball looking into the future.

While this could be a single quarter outlier, the latest Housing Affordability Index is worth taking a serious note. If the current number of 23 is maintained over the next quarter(s), or even drops, then that could be a strong indicator that the market is finally overheated.

In some positive news, California condos/townhomes still offer affordability of 37%.

That said, if a buyer wants to purchase California’s median-priced home of $817,950, then according to C.A.R. they need to be earning $150,800 as the minimum.

Compare that to median home prices of our local markets:

  • Manhattan Beach: $2,922,809

  • Hermosa Beach: $2,040,000

  • Redondo Beach: $1,295,000

  • Palos Verdes 90274 Zip: $2,327,000

  • Palos Verdes 90275 Zip: $1,700,000

How much do you need to earn to afford those homes, and can the strength continue?

Obviously, you need a lot more than $150,000 to buy a home in Palos Verdes and the Beach Cities.

While South Bay buyers have been able to afford expensive prices up to this point, one needs to still focus on the numbers, history, and current market activity to see if we can sustain this market strength or if it might be time for a plateau, or even a small correction.

It is too early to tell with the Housing Affordability Index, but this latest number could be a very early warning sign that the market might have peaked or is even due for a correction.

This is an important story to follow and rest assured, I will bring you the Housing Affordability Index updates for Q3 and Q4 as they come.

Stay tuned and have a great weekend!

DRE: 01779425

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