I’m always searching for reasons why things are the way they are. It’s also fun to connect the dots and come up with an investment thesis to make a lot of money. What I’ve recently discovered is that because the minimum qualifying income required to purchase a house is so low, there is still a lot of upside to housing prices.
For years now, I’ve made the case that Americans earn more and are wealthier than we all like to think. And finally, after three years of waiting, the U.S. Census Bureau came out in 2020 with 2019 data saying the real median household income has reached $68,703.
$68,703 is a healthy middle-class income. The question now is: Is $68,703 a high enough household income to afford a median-priced home?
Let’s look at data from the California Association of Realtors (CAR) on the required minimum household income to afford a home.
Minimum Qualifying Income Required to Purchase A House
You’ll see below that for the United States as a whole, the minimum qualifying income required to purchase a home is only $54,800!
If what CAR reports is accurate, then the median household, which earns close to $69,000 annually, has a healthy $14,000 income buffer to purchase a home. Put in a different way, the median U.S. household can afford monthly mortgage payments which are 25.5% higher than the mortgages of a median-priced home.
The CAR Traditional Housing Affordability Index is explained here. The calculation assumes a median price home, a 20% down payment, the national average effective mortgage interest rate on all fixed and adjustable-rate mortgages, and Principal, Interest, Taxes, and Insurance (PITI) of no more than 30% of a household’s gross income.
Many homebuyers put less down than 20% and spend more than 30% of their household gross income on PITI. Therefore, I say the CAR’s definition of housing affordability is pretty accurate.
Up To 25% Further Upside In U.S. Home Prices
If mortgage rates and the median U.S. household income stays the same over the next several years, then theoretically, U.S. home prices have roughly 25% further upside.
If the price for a median-priced home in the U.S. is currently $291,300, then in several years, the potential price for a median-priced home in the U.S. might be $364,125.
Of course, every housing market is different. 18-hour cities are likely going to appreciate faster than 24-hour cities in the short-term. Therefore, you may want to diversify your real estate investments accordingly.
However, long term, I still am bullish on 24-hour cities due to continued strong job opportunities, network effects, and more.
I believe mortgage rates are going to stay low for at least the next decade. Further, I believe the median household income will stay buoyant. It’s hard to see real U.S. median household income collapsing by $14,000 to $54,800 in several years. Even if it does, mortgage rates will likely be even lower to support housing affordability.
Therefore, there’s still plenty of upside in the U.S. housing market. By 2026, the U.S. median home price could easily be 20%-25% higher. The biggest tailwind is that the millennial generation is in its family formation years.
Surviving In An Expensive City
Now that I’ve made a bullish case for the U.S. median home price, let me focus the attention on how to survive in San Francisco with two children and two stay at home parents.
To track middle-class expenses, I pay attention to the minimum qualifying income required to purchase a home and the cost of healthcare. I also keep track of private school tuition, which is more an upper-class decision.
A middle-class lifestyle is all we can reasonably ask for. However, thanks to inflation, tremendous competition, and a dramatic decline in interest rates, it’s getting harder to achieve a middle-class lifestyle status or stay in the middle class.
In 2018, when I wrote, Why Households Need To Earn $300,000 To Live A Middle–Class Lifestyle In An Expensive City, the post received plenty of backlashes. The general consensus was that needing $300,000 to raise a family was way too much, despite the cost of living saying otherwise.
To be clear, the post was in response to the California Association Of Realtor’s (CAR) calculations, not mine. Now we know the income level today is closer to $322,000, which is 7.3% higher. See the latest figures below.
Cross-Checking The Minimum Income
$322,000 sounds like a big minimum income. However, if you follow my 30/30/3 home-buying rule, $322,000 is actually not big enough! This is because the median home price in San Francisco is about $1,600,000. Therefore, a household would need to earn a median income closer to $533,334.
But I’ve also said that for households living in an expensive area can stretch to 5X their household income. This is mainly due to a dramatic decline in mortgage rates. Therefore, $322,000 X 5 = $1,610,000, which is spot on with the median home price in San Francisco.
Thankfully, six-figure incomes are a dime a dozen in places like the Bay Area. The average starting compensation package for college graduates joining big tech is over $100,000. The greater difficulty may be coming up with a 20% down payment plus a 10% cash or liquid securities buffer.
A $1,288,000 mortgage after putting 20% down at a 3% mortgage rate is only $5,430 a month. $5,430 is an affordable 20% of a $26,833 monthly gross household income ($322,000 annual).
Now let’s move on to healthcare costs.
Healthcare Costs Are Surging
If a household is self-employed or unemployed, the household will have to bear the entire cost of its family’s healthcare insurance premiums. Based on my research for Gold and Platinum plans, the annual cost for a family of four will be between $27,000 – $30,000 for 2021+.
Hopefully, at least one spouse works and gets subsidized healthcare. That said, it’s much harder for one spouse to earn the required minimum of $322,000 by him or herself.
Take a look at the details of these two real healthcare insurance family plans we are considering. Does $2,532/month for healthcare sound reasonable to you?
A Struggle For Retirees With Debt
Mortgage debt is the reason why a $322,000 a year minimum household income is needed to live a middle-class lifestyle in an expensive city.
If you are able to pay cash for your home or pay off your home, a $322,000 a year household income becomes unnecessary. One can simply take the $5,430/month ($65,150/year) mortgage payment on a median-priced home after putting down 20% and subtract it from $322,000 to get a new minimum required income of $256,850 ($21,404 a month).
But even the need to earn $21,404 a month seems to be unnecessary with a mortgage. Let’s say you have two kids attending private school for $10,000/month total. You’re left with $11,404 a month for food, clothing, maintenance, taxes, travel, and transportation.
$256,850 a year in household income for a household without debt should be more than enough. My family of four comfortably live on less than that a year.
The Temptation To Cheat On Passive Income
As the cost of living goes up, there is a growing temptation by retirees or people seeking to retire to cheat on what is considered passive income.
Instead of just including income from investments as the only source of passive income, some people have started including active income from their online business, consulting income, food delivery income, and more as sources of passive income.
Cheating might temporarily make you feel better about quitting a high paying job. But deep down you will feel bad knowing that you haven’t really achieved financial independence.
A better solution is to just own up to the fact that you are not financially independent. This way, you are mentally free to actively try and make more income. In a permanently low-interest-rate environment, we must adapt.
Keep On Planning A Couple Years Ahead
After readers started saying I was an early retirement failure for wanting to go back to work in 2018 to prepare for a potential downturn, I decided to accept the criticism and hang a lantern on my failure. As soon as I fully embraced failure, I started making a lot more money.
I’m very grateful for the constant criticism in order to improve my finances and our family’s lifestyle. So please keep it coming!
By thinking a couple of years ahead before our daughter was born, we were able to better prepare financially for her added cost. We were also able to invest in some stocks that have done really well since 2018.
Finally, we were able to buy a larger single-family home with cash in anticipation of needing more space. Buying a house after the baby arrives is like shopping for groceries while starving.
The cost to live a middle-class lifestyle will likely keep going higher thanks to inflation and market forces. But that’s what our investments are for! To not only keep up with inflation, but beat it soundly year in and year out.
Personally, I enjoy the challenge of trying to stay financially ahead in one of the most expensive cities in America. If we move to Honolulu in Fall 2022, the cost of living there will feel comparatively inexpensive. Let’s just hope our son gets in somewhere.
It is awesome to be able to take out cheap debt to increase our standard of living. It is also equally awesome to pay down that debt and become debt-free. When the time comes for you get off the income treadmill, plan on being debt-free.
Without debt, life really does get much easier.
Real Estate Investment Alternatives
Given I believe there is potentially 25% upside to the U.S. median home price, investing in real estate is a core part of my wealth-building strategy. One way to invest in real estate across the country is through real estate crowdfunding.
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise. Fundrise offers customized real estate funds for diversification and diversified real estate exposure.
If you are an accredited investor and like to invest in specific commercial real estate opportunities, check out CrowdStreet. CrowdStreet is focused on real estate deals in 18-hour cities where valuations are lower, cap rates are higher, and growth may be stronger as well due to strong demographic shifts.
Both platforms are free to sign up and explore. As part of my real estate diversification strategy away from San Francisco real estate, I’ve invested $810,000 in 18 different real estate crowdfunding deals across the country.
Readers, are you bullish on housing given the minimum qualifying income to buy a home is so low? If so, how much more price upside do you see, and in what time frame?