The Beast of Burden: Housing Affordability and Debt Service

“In our view, we anticipate a rise in property values over the next five years, owing to several improving market conditions. Despite potential short-term challenges with weakening fundamentals, an influx of new inventory and looming debt obligations, we foresee a decline in interest rates by 2024. This, coupled with stabilized inventory and robust rent growth, is poised to ignite another market cycle upswing.

Our approach typically favors buyers who demonstrate a commitment to equity and thorough upfront due diligence, especially regarding debt and insurance considerations. Given the market's volatility, we prioritize buyers' readiness for potential interest rate hikes and sound insurance coverage. In this volatile landscape, failure to address these aspects can relegate a buyer's offer to the bottom of the pile, as we diligently manage risk for our seller clients.

Undoubtedly, we've witnessed pricing pressure due to escalating interest rates and turmoil within the insurance sector, particularly in Florida. Despite a substantial pool of multifamily acquisition buyers in the state, a notable bid-ask spread persists, primarily driven by the desire for favorable leverage and well-structured deals with tax and insurance adjustments. These adjustments are necessary, given that interest rates have surged to all-in rates exceeding 6%, and insurance costs have reached burdensome levels, often surpassing $2,000 per unit.”

- Mike Donaldson, Vice Chairman at Cushman & Wakefield/

Hi Nuvo Community,

Key Highlights:

• Rising Rent CPI: Rent Consumer Price Index (CPI) is outpacing the growth in average hourly earnings in the United States, widening the affordability gap.

• The Cumulative Effect: Rent CPI has grown 10.54 percentage points more than average hourly earnings since 2008.

• Affordability Challenges: The data suggests potential affordability issues if the trend continues, impacting U.S. workers across most industries.

• Macroeconomic View: The trend has wider implications for consumer spending, economic mobility, and long-term socio-economic policies.

In commercial real estate and multifamily investing, the devil is often in the details—or in this case, in the data. Nuvo Capital Partners does a deep dive into every market we look at investing in. In this week’s report, we’re sharing and discussing a couple of under-utilized data points. We’ll cover their importance, interactions, and implications for the CRE markets. For this report, we collected data from the Federal Reserve of St. Louis and Bureau of Labor Statistics on the 12 most populous counties in the U.S. to examine housing affordability and implications for multifamily investment decisions. The following report is a summary of our findings.

The Data Sets Explored

Burdened Households: This metric provides an account of households in the 12 most populous U.S. counties that are "housing-cost burdened," meaning they allocate over 30% of their income to housing expenses. The data spans from 2010 to 2021. The term "burdened households'' might sound abstract, but it's a critical barometer of financial strain. Imagine earning $5,000 a month and spending $2,000 on rent or mortgage—that's 40% of your income, making you a 'burdened' household. After covering your housing costs, you have less money to spend on other items than someone only paying $1500 on rent.

Household Debt Service Ratio: The DSR is divided into two parts. The Mortgage DSR (MDSP) is total quarterly required mortgage payments divided by total quarterly disposable personal income. The Consumer DSR (CDSP) is total quarterly scheduled consumer debt payments divided by total quarterly disposable personal income. The Mortgage DSR and the Consumer DSR sum to the DSR.This set includes the household debt service ratios data stretching from 2010 to 2022. Quite simply, this is the percent of household disposable income spent on debt payments.

The Tale of Burdened Households

This report synthesizes over a decade of data from 2010 to 2021 on household debt service payments, burdened households, and 30-year mortgage rates to offer an in-depth look at the interconnected variables that are poised to impact (and already are impacting) the real estate sector. The evidence suggests a strong positive correlation between household debt service and the percentage of burdened households (meaning they tend to move in the same direction). Furthermore, a lagged but substantial impact of mortgage rates on these variables is anticipated (meaning when mortgage rates go up, burdened households follow). The findings are particularly relevant in the context of the sharp rise in rental costs in 2021, emphasizing the need for a deeper understanding of specific markets you intend to invest in.

As shown in the chart above, from 2010 to 2021, the average percentage of burdened households in the 12 most populous U.S. counties has gradually decreased. It started at an average of 46.8% in 2010 and declined to 40.6% by 2021 (a drop of 6.2 percentage points). Meaning that up until 2021, these households have been spending less and less of their incomes on housing (a welcomed thing for renters and policy makers alike). However, it's worth noting that this dataset does not capture the unprecedented increase in rental costs observed in 2021.

The Correlation Story

Let’s put a pin in that and move on to our next data point, Household Debt Service Ratio (DSR).

(DSR) serves as a useful metric for understanding financial stress, as it measures the ratio of total household debt payments to disposable income (the percent of income spent on debt). Analysis reveals a robust correlation coefficient of 0.793 between Debt Service Payments and the Average Percentage of Burdened Households. This essentially means that they move in the same direction about 79% of the time. And it makes sense, when debt service payments are lower, households are less burdened. Both metrics have trended downward in a near-parallel fashion over the past decade. See the chart below for an illustration: Debt Service Payments are represented by the red line and Average Percentage of Burdened Households are represented by the blue line.

You have noticed that data for burdened households stops in 2021; the latest available data from the Federal Reserve. DSR shot up in 2021. If the historical correlation holds, we can expect the percent of burdened households (blue line) to increase right behind debt service ratios (red line). Now let’s look at the picture when we incorporate 30 yr mortgage rates.

The Mage Rates Overlay

When 30-year fixed-rate mortgages are added to the chart above (green line), a complex but revealing pattern emerges. The data suggests a likely escalation in the percentage of income spent on debt service payments, and correspondingly, an increase in burdened households in the near future. Mortgage rates can be seen as a leading indicator for Burdened Households and DSR. They have trended downward over the last decade as well, falling from a high of just over 4.5% to a low of just under 2%. As shown in the chart above, mortgage rates have drastically increased over the last year (along with US10YR and SOFR). Whether households are renting or buying in the coming years, they should expect an increasing percentage of their incomes to go towards housing and other debt payments.

Implications

For real estate investors- know the market you are investing in, or at least make sure your operating partner does. Does the submarket already have a high percentage of burdened households? A high debt service ratio? These are just 2 of the more than 100 data points Nuvo Capital Partners collects and analyzes before investing in a market.

Happy Real Estate!

All the best,

Yuri - Your Real Estate Investigator

Credit: Brian Underdahl, Chief Analytics Officer of Nuvo Capital Partners

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