3.1 Factors that Contribute to Housing Affordability
There are several factors identified in the literature that contribute to the affordability of housing (DTZ New Zealand 2004):
- Income (current and expected lifetime): directly impacts on a household’s ability to purchase and make housing payments
- House prices and rents: represents the level of payment that is required to secure housing
- Interest rates, nominal and real: determines the cost of borrowing for home owners
- Labour market conditions: affects a household’s ability to participate in the labour market and earn an income, and thus be able to maintain housing costs over a period of time
- Mortgage and rent payments: directly impacts on a household’s ability to save and increase their housing consumption in the future. This is especially relevant for households in the rental market who are looking to purchase a house
- Supply constraints: may limit the ability of the market to respond to excess demand for housing
These factors are clearly interrelated. Labour market conditions directly affect people’s incomes, specifically their certainty of future income streams. Mortgage and rent payments are determined by interest rates, house prices, rents, and wealth. Supply side constraints affect house prices. Interest rates can also affect house prices as a result of changes in demand for purchasing a house.
3.2 Affordability Measures
There are two broad groups of affordability measures. These can be termed ‘shelter first’ and ‘non-shelter first’ measures (Burke 2004).
The shelter first approach assumes that housing has first claim on the household budget, and other expenditure is met from the remainder. Conversely the non-shelter first approach assumes that other expenditure has first claim, with housing costs met from the remainder.
The shelter first approach is the most common. There are two main types of measurement in this group. They are an outgoings (on housing) to income ratio (OTI), and a residual income measure (RI). A third type, similar to OTI, is a house price to income ratio.
These measures are applied differently for renters and for home owners. Firstly we analyse rental measures, followed by the home ownership measures that build on them.
3.2.1 Affordability Measures for Rental Tenure
For renters, the OTI is measured as a rent to income ratio. Rent is divided by income for some time period (e.g. weekly, monthly). We can then find the proportion of households with an OTI above some pre-determined level. The more households above this level, the less affordable is renting. Alternatively, we can find the average rent divided by the average income. It is not always appropriate to use averages; measures such as the median, the lower quartile or the 10th percentile may give a more useful picture in some contexts. A high average OTI indicates relative unaffordability of renting.
The RI measure is simply a person’s income less their rental payments, for a given period of time. Again, we can calculate the proportion of households below some level, where a higher number indicates relative unaffordability. Also, we can calculate an average RI, where a low value indicates relative unaffordability.
It is evident that we have to define some ‘norm’ when using these measures; i.e. at what level of OTI is housing deemed ‘unaffordable’. Further discussion of this occurs later.
3.2.2 Affordability Measures for Home Owners
For home owners, these measures are more difficult to calculate. The OTI for existing home-owners is a ratio of mortgage payments to income. For would-be homeowners, the relevant outgoings are the potential mortgage payments given their deposit and current interest rates and house prices. The residual income measure for both existing and would-be home owners is then income less the above mortgage payments.
There are differences in these measures for would-be home owners / new home owners, and long term homeowners. Would-be home owners often face higher interest rates, usually with a small deposit. Long term homeowners may have much lower monthly repayments, or have fully paid off their loan.
Again, there are two specific ways to analyse an OTI, both of which are useful. Firstly, one can calculate the proportion of all households which have an OTI above a certain level. This could apply to all households, or a subset, such as those in some low-income bracket. The alternative method is to calculate the ratio of average outgoings to average income.
3.2.3 Non-shelter First and Other Measures
The rarely used “non-shelter first” approach assumes that other expenditure has first claim on the household budget, with housing costs met from the remainder. This requires some estimate of the cost of all non-housing necessities (or quasi-necessities). Measures used in Australia have been the Henderson poverty-line, and a budget standard developed by the Social Policy Research Centre (Burke 2004). Banks also use similar methods to assess non-housing costs, as part of determining suitability for credit.
This is exclusively a residual income approach, representing the income left over for housing once a minimum living standard is deducted from income. We do not use non-shelter first measures in our evidence.
There are other possible measures for affordability. The ratio of average house price to average income is often used due to its simplicity for calculation and understanding.
Another often-cited measure is Stone’s “shelter-poverty” standard (Stone 1994). Stone uses a sliding scale to analyse the required income for various housing types and compositions to meet non-housing costs, and whether their income is sufficient for this. Despite being a very informative measure, it is essentially a more complex version of the residual income method, and still requires normative decisions.
Massey University has measured the length of time needed for a household to accumulate a 10% deposit on the median house in their region, based on various monthly savings (DTZ New Zealand 2004). However, as cited, this method effectively gives the same relative results as comparing house prices across regions. The only data used are average house prices, an assumed 10% deposit, an assumed interest rate, and arbitrary monthly savings figures. There is no consideration of how easy it is to save these amounts neither in relation to income, nor to the differences in this savings ability over time and across regions.
Another possible measure is a ratio of income to construction costs. Although this is essentially an OTI, we consider it separately. This is a way of comparing the ability to pay criterion against construction costs, rather than house prices. The problem with this measure is that the main contributor to house price changes in NZ over the last two decades has been land values, not construction costs (DTZ New Zealand 2004). Hence simply using construction costs as a benchmark is misleading, in that it does not consider the most significant element of the changing affordability of purchasing a house.
3.2.4 Different purposes
All the measures outlined above are used as tools for analysis of the housing sector and several are used to varying degrees for policy purposes.
The rent-to-income OTI measures the affordability of rental tenure. It can be used for several purposes in relation to state housing and accommodation benefits. In New Zealand it is used as one factor to set rent levels for state house tenants.; ie the tenants pay 25% of their income as an Income-Related Rent. OTIs are also used as one factor when assigning priority for access to state housing in New Zealand, for setting levels of housing assistance and assessing people’s eligibility for benefits.
The prospective mortgage-to-income OTI measures the affordability of purchasing a house today. The ratio of house prices to income performs a similar function. The OTI measuring the number of households with housing costs above some proportion of income indicates the affordability of households’ current homes, for all households.
The RI measures tend to be able to be used for similar purposes as their respective OTI. RI’s added use is in determining eligibility for, and the level of, income assistance.
- We do not encounter this difference in our evidence, as we do not calculate average RIs. In all our later evidence, a low value is relatively more affordable than a high value.
- Data used from the Household Economic Survey includes rates and repairs together with the mortgage payments.
- For a recent analysis of housing costs and the role of land prices see Grimes and Aitken (2006).