Buying a Home in California? Income Is Becoming Less Important than Wealth
This post draws on interactive data on income and housing affordability, provided as a resource for California legislators and the public.
Yifan Wu. Image from The New York Times, August 2, 2019.
Five decades of economic strength coupled with increasingly restrictive land-use policy have made California unaffordable to most people. It also risks fundamentally altering the divide between haves and have-nots.
More than ever, existing property owners benefiting from rising home prices stand in stark contrast to recent arrivals to the market, including younger generations of Californians.
Now there is evidence suggesting that wealth, be it born of homeownership or something else, is gradually eclipsing income as the key factor when it comes to homeownership. The need for wealth has had the insidious dual effect of limiting the pool of buyers and keeping properties held in the family off the market.
Let’s take a step back. To calculate housing affordability, economists typically look at households’ monthly housing costs as a fraction of their income – the housing cost burden. Household incomes have increased over time in California, but housing costs have increased even more. The share of cost-burdened households – those that spend more than 30 percent of their income on housing – has risen for every age group.
But housing cost burdens consider only monthly costs, such as rents or mortgage payments. They gloss over the need for a down payment or the ability to swap cash for borrowing–when that’s possible.
Another affordability metric, the price-to-income ratio, takes the full cost of a home into account by weighing the typical local home price against residents’ annual income. By that measure as well, housing in California is unaffordable for most.
A large cash down payment is one way of getting around high price-to-income ratios and making a monthly mortgage manageable. And just as a large down payment can lower the monthly mortgage by reducing the amount borrowed and lowering the interest rate paid, a small down payment can make the monthly bill much higher.
As home prices soar, so does the size of required down payments. For most people, saving hundreds of thousands of dollars to put down on a house in California can take years or even decades if it can be accomplished at all, especially when soaring rents make it harder to save.
As savers put off purchasing, the pool of would-be buyers shrinks and changes. Today’s market increasingly favors cash buyers, existing homeowners armed with equity, and people with inter-generational assistance–money from parents or grandparents.
The latter can be manifested in things like college funds, hand-me-down cars, or a place to crash rent-free for a while. Such assistance seems superficially unrelated to housing and is vastly under-reported as an indirect source of homebuying funds.
When price-to-income ratios climb high enough, tackling home prices with income alone becomes infeasible, and homeownership comes to depend less on income and more on wealth. In that state of affairs, even very well-earning individuals may find themselves priced out of homeownership unless they’re lucky by birth.
And if you want your children and grandchildren to live nearby, it could depend on you more than it does on them.
Take a hypothetical first-time buyer. In greater Los Angeles, adults aged 25 to 34 have a median income of $83,000 and a price-to-income ratio of 7. They’re extremely cost burdened.
If a typical home costs $587,000, the 20 percent down payment required for the cheapest mortgages would amount to $117,400–more than the young household’s annual income. Closing adds even more to that up-front cost.
For many adults getting married or starting families, homeownership is simply impossible unless they have wealth from day one–or help.
Now a wealth-related phenomenon is emerging. Since 2000, the share of California residents in households who own their homes free and clear has grown across every racial group and among all but the oldest households.
The share of owner-occupied houses with a mortgage, meanwhile, has been shrinking. That’s partly because more people now rent. But it’s also because more residents didn’t take out a mortgage to buy to begin with. They paid cash or inherited their houses.
The growth in free-and-clear ownership can be seen across all regions of the state. The trend extends to even the youngest households, with residents 24 and younger. In addition to reflecting the increasing concentration of the nation’s wealthy in California, this growth might be the result of more young adults living with their parents – or more young adults living in homes their parents bought them.
Such inherited or gifted houses lock in wealth for future generations, and in some cases keep a property itself in the family for generations. That’s particularly common in California owing to property tax laws – Prop. 13 and its extensions – and the practice keeps a sizable share of homes off the market interminably.
In the greater Los Angeles region, the share of free-and-clear owners among households with residents aged 24 to 35 – peak household formation years – doubled since 2000 to 8 percent. In the Bay Area, the share more than doubled, from 3 percent to 8 percent.
Population Share by Housing Tenure: California (2000 vs 2015-2019 average)
Conversely, older Californians have suffered a decline in free-and-clear ownership. That’s consistent with today’s prolonged climb up the homeownership ladder. People are becoming first-time homeowners later in life for a variety of reasons, including the greater financial challenge, and mortgages are being paid off later, if at all.
It’s consistent, too, with the theory that more parents are supplying their children directly with down payment help, or indirectly by helping with college or other expenses that would otherwise eat into saving for a down payment. For many parents, one way to help the kids is to borrow against their own homes, which has the side effect of delaying the parents’ own graduation to free and clear ownership.
In an environment like this, programs that offer low-down-payment loans have limited value. Scrimping on a down payment is always costly. Federal law favors homebuyers with less debt and mortgage lenders give the best terms to borrowers who can put at least 20 percent down.
Even sellers can be biased toward buyers who promise a large down payment, which, in theory at least, reduces the odds that a loan and the sale will fall through.
Today, the homeownership rate in California is 54.2 percent, well below the nationwide rate of 65.4 percent and the lowest of any U.S. state. Only the District of Columbia has a smaller share of homeowners. As the homeownership rate falls, wealth becomes even more concentrated.
As buying a house gets further out of reach for most Californians, homeownership is becoming less an achievement of the American Dream and more a stark symbol of wealth.
If California stays on this track, it could eventually come to resemble Manhattan. As of 2019, only 23.3 percent of households in Manhattan owned their homes. In contrast to the rest of the country, homeownership in Manhattan implies a certain class status all on its own.
If you don’t belong to a distinct social class, and you don’t have or expect to have the wealth to buy your kids a home, odds are good that they’ll join the flow of domestic migration from California to cheaper parts of the nation.
And who can blame them? Five decades of restrictive land-use policy have taken their toll, and that won’t change unless we enact land-use reform that paves the way for enough housing to accommodate everyone who wants to live here.
That means saying “Yes! We welcome more homes in the neighborhood. Period.”
If you want your children and grandchildren to live nearby, it could depend on you more than it does on them.