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What Is Housing Affordability?

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Jan. 22 2016, Updated 1:17 a.m. ET

Housing affordability defined

The US Department of Housing and Urban Development (or HUD) considers a house to be affordable if the cost of the total rent or mortgage plus utilities are ~30% or lower of the household’s annual income. The total housing costs are related to a family of four earning at or below 80% of the area median income.

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Affordability

To make it simpler, we can use a general rule of thumb that says that the monthly mortgage payments should not exceed ~30% of your monthly take-home salary. Alternatively, the cost of the house should not exceed three or four times your annual income. For example, if you take home $6,000 per month, your monthly mortgage payments should not be more than $1,800 to allow you to pay other recurring expenses without strain.

According to the study undertaken by McKinsey Global Institute, there were only 3.3 million rental units affordable and available to the 11.5 million extremely low-income households. This data is only indicative and although it is a couple of years old, it shows the gravity of the situation.

REITs to benefit

The lower home affordability level means that homebuyers must delay their homebuying decision and continue renting instead. This trend bodes well for apartment REITs like Equity Residential (EQR), AvalonBay Communities (AVB), Essex Property Trust (ESS), and Camden Property Trust (CPT), which earn income by renting residential properties to tenants.

Investors can get exposure to the apartment REIT sector by investing in the SPDR Dow Jones REIT ETF (RWR), which invests ~4.9% of its portfolio in Equity Residential (EQR).

Continue to the next part of this series for a discussion on the affordability level in regional markets.

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