There is no agreed best measure of housing affordability. There are also several factors driving home ownership affordability, including house prices relative to incomes and financing costs. In turn, these are influenced by the availability of credit, interest rates, the inflation rate, and the terms and conditions of loan contracts. So this chapter presents a number of measures of affordability for would-be home owners, each of which has different strengths and weaknesses.28
House price ratios
The ratio of house prices-to-income, which shows the number of years of household disposable income needed to cover the purchase price of a house, is the simplest measure of affordability. During the 1980s, house prices fluctuated between about 2 and 3 times annual disposable household income (Figure 4.1). Over the 1990s, house prices rose to more than 3 times annual disposable income before accelerating sharply to about 5.5 times household income by 2007. Since then, the number of years of income required to buy a house has declined slightly to just under 5 in 2010, but remains well above the long-term average. Figure 4.1 House price ratio
Source: Productivity Commission calculations using Reserve Bank of New Zealand data
Affordability measures that include borrowing costs
The ratio of house prices-to-income does not account for the cost of housing finance, which is the largest ongoing cost for most home buyers. As well as being large, financing costs can fluctuate noticeably over the course of the business cycle and thereby have an important influence on changes in affordability (Figure
4.2). This is apparent from the measure of ‘borrowing capacity’ developed by Briggs and Ng (2009) (Figure 2.6, Chapter 2). This measure reflects the amount a household earning the average income could borrow via a table mortgage at the effective mortgage rate.29 This measure shows that although the ratio of house prices-to-income increased sharply during the 2000s, the borrowing capacity of households also increased strongly over this period. In effect, and as discussed in Chapter 3, lower mortgage rates enabled
households to service larger home loans, and thereby reduced the impact of rising house prices on affordability. Of course, as discussed in Chapter 3 lower interest rates may have also contributed to the increase in house prices.30
Figure 4.2 Effective mortgage interest rate, real and nominal
Source: Productivity Commission calculations using Reserve Bank of New Zealand and Statistics New Zealand data Notes:
1. Real mortgage interest rates are calculated by deflating the nominal interest rate by the average of the previous four quarters’ and the forthcoming four quarters’ change in the CPI. Because forthcoming changes in the CPI for the 2011 calculations were unknown at the time of writing, the real interest rates for 2011 assume the CPI increases at 0.5% per quarter from 2011Q1 onwards. 2. GST was increased from 12.5% to 15% in 2010Q3, contributing to higher inflation rates around this time.
Other measures of housing affordability that account for the impact of financing costs confirm that interest rate changes can mitigate the impact of rising house prices. Massey University’s housing affordability index is calculated using data on median house prices, average earnings and interest rates, and thereby also incorporates financing costs (Figure 4.3).31
The significant cycles in this index appear to have had different underlying causes. In the late 1980s, although house prices were relatively stable, high interest rates resulted in relatively low affordability levels. More recently, deteriorating affordability over the 2000s was driven by rising house prices, rather than by higher interest rates. According to this measure, affordability has improved since 2008 and is now around its average long-run level, given lower interest rates and softening house prices. Indicative of the regional supply constraints, according to this measure, housing is always less affordable in Auckland.
29 The effective mortgage interest rate is the average rate of all the housing mortgages that are currently in place.
30 Briggs and Ng (2009) conclude that the fall in interest rates and nominal inflation had an effect on house prices, although other factors (such as
increases in section prices, construction costs, and access to credit) also contributed.
Figure 4.3 Massey home affordability index
Source: Massey University Real Estate Analysis Unit Notes:
1. A low index indicates improved affordability.
Roost Mortgage Brokers also publish indicators of housing affordability that incorporate financing costs. These indicators are calculated as the proportion of weekly take-home pay that a ‘typical’ and ‘first-home’ buyer would need to spend to service their mortgages. A typical buyer is assumed to be purchasing at the median house price with a 20% deposit. The first-home buyer is assumed to be buying a house at the lower price quartile, with a deposit that is estimated as a function of savings.32 The time path of these indices is
similar to the Massey index.
The proportion of median income of an individual in the 30–34 age group required to service the mortgage on a median home rose from about 40% in 2002 to 83% in June 2008 and then fell to 52% by October 2011.33
The proportion of median income of an individual in the 25–29 age group required to service the mortgage on a house priced in the lower quartile increased from about 40% in 2004 to 73% in September 2007 and then fell to 44% by October 2011.34
The Massey and Roost indices are nominal measures of housing affordability. Nominal measures reflect ‘actual’ affordability by highlighting the difficulties of meeting the terms and conditions of a mortgage contract for those who need to borrow to purchase a house. However, some of these difficulties are not caused by the purchase price of the house nor the real interest rate, but by inflation. As such, it is also useful to examine housing affordability in real terms by removing the effect of inflation and measuring ‘underlying’ affordability (Box 4.1).35
32 The first-home buyer deposit savings is equal to 20% of weekly income saved for four years, plus interest earned at a 90 day deposit rate. 33 Figures are from the Roost Home Loan Affordability Index: standard series.
34 Figures are from the Roost Home Loan Affordability Index: first-home buyer series.
35 See Coleman (2008) for a detailed discussion of inflation and the measurement of housing affordability.
Box 4.1 Inflation and the measurement of housing affordability
Inflation results in ‘front-loading’ of mortgage repayments since it leads to larger real principal
repayments during the early stages of home ownership. Home loans in New Zealand are typically table mortgages, which require a series of monthly payments determined by the loan’s maturity term and the nominal interest rate. For instance, if inflation is 2% per year, the real value of repayments on a 25
Housing affordability measured in nominal terms is considerably worse than real affordability, and the gap increases with the inflation rate. The number of hours of work, paid at the average hourly rate, required to service the nominal interest payments on a median priced house is much higher than the number of hours work required to service the real interest cost (Figure 4.5). The nominal and real indices follow a similar trend, with both deteriorating during the recent house price boom, but improving more recently.36
However, part of the deterioration in nominal housing affordability during the house price boom was due to high inflation rates. In fact, while nominal affordability was at its worst during this period, real affordability was better than in the mid-1990s.
36 Nominal affordability has continued to improve recently while real affordability has worsened since late-2010. This is likely to be due to the 2010Q3
increase in GST and the resulting rise in the inflation rate. This higher inflation meant real affordability improved faster than nominal affordability, before worsening somewhat.
year loan of $100,000 with a 7% interest rate declines from about $8,400 at the end of the first year to $5,200 at the end of the 25th year. In contrast, if the inflation rate was zero, there would be a constant repayment of about $7,100 a year over the life of the mortgage (Figure 4.4).
Figure 4.4 Real repayment stream of a 7% 25 year $100,000 mortgage (inflation=2%)
Source: Coleman (2008) modified.
Another way to view this is when nominal interest rates rise due to inflation, monthly mortgage payments also rise, but the increase reflects more rapid real principal repayment rather than a higher real cost of housing. For example, if someone takes out a $100,000 loan at an interest rate of 7% per year when inflation is 2%, the $7,000 interest payment comprises $5,000 real interest payments and $2,000 to compensate the lender for the erosion of the initial value of the capital due to inflation. This $2,000 is effectively saving by the borrower because it reduces the real value of the remaining debt to $98,000. So while nominal affordability indices provide useful information about the financing
difficulties facing credit-constrained households, they overstate the average lifetime cost of the mortgage as they do not take into account the expected decline in the real value of the payment stream over the life of the mortgage. An index based on the real mortgage rate makes this adjustment.
Figure 4.5 Real and nominal affordability indices
Source: Coleman (2008) updated. Notes:
1. The nominal (real) index is calculated as: 𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦 𝐸𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑆𝑢𝑟𝑣𝑒𝑦 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 ℎ𝑜𝑢𝑟𝑙𝑦 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑛𝑜𝑚𝑖𝑛𝑎𝑙 (𝑟𝑒𝑎𝑙)𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒∗𝑄𝑉 ℎ𝑜𝑢𝑠𝑒 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥
2. The QV house price index is rebased to equal the median house price in March 2006 ($295,000).
While real affordability indices remove inflation and therefore better reflect the lifetime cost of a mortgage, this is no consolation for a would-be homeowner who faces high debt repayments, particularly during the early stages of homeownership. Higher inflation rates make it more difficult for households to meet the terms and conditions of a mortgage. This highlights that with standard mortgage contracts, even moderate levels of inflation can negatively impact on the ability of credit-constrained households to meet home loan borrowing costs.
Disaggregated measures of housing affordability
The aggregate indices discussed above are useful for tracking changes in affordability over time. However, they are based on average measures of household income and house prices and do not necessarily indicate what is happening to affordability for different types of households. In contrast, disaggregated measures track affordability for a range of different household types, including by income, age, ethnic background or location in New Zealand.
Differences between income levels
The affordability of housing for people on different incomes can be investigated with a model that uses data from the Survey of Family, Income and Employment (SoFIE).37 This model examines nominal
affordability for those who are aged 25 years and over and do not currently own the house they live in. It takes account of factors such as the net assets available for a deposit, income and the prevailing interest rate. For each household the model asks: could they afford to purchase a lower-quartile priced house in their region without mortgage payments exceeding 30% of their gross income?38
The results of this model show that the proportion of individuals that could afford to buy a home is higher for couples – who often have higher (combined) incomes and wealth – than for individuals (Figure 4.6). According to this model, affordability fell between 2003/04 and 2007/08 for all except couples in the highest income quintile. However, as with the aggregate results discussed above, these trends may have reversed subsequently given that house prices and interest rates have fallen since 2008.
37 A full description of the model, along with a richer set of empirical results, can be found in Law and Meehan (2012).
38 The main disadvantage of SoFIE is that data on assets and liabilities is only available for three years - 2003/04, 2005/06 and 2007/08. The most recent
Figure 4.6 Housing affordability by income
Singles1 Couples
Source: Productivity Commission and Treasury calculations using Statistics New Zealand Survey of Family, Income and Employment data
Notes:
1. The figure for quintile 1 in 2007/08 is not presented for confidentiality reasons since the number of those who could afford was very small. Income quintiles are based on non-home owners and are calculated separately for singles and couples.
Differences between age levels
Affordability generally increases with age, in large part reflecting the higher incomes that come with greater work experience (Figure 4.7). However, the oldest age groups buck this trend, perhaps reflecting that while most older people already own their home, some, such as the lifetime poor, cannot afford to buy a house. It also reflects that incomes tend to be lower in this age group due to retirement. Some older people may also have experienced adverse shocks such as marriage dissolution or financial issues late in life, leaving them little time to recover financially.
Figure 4.7 Housing affordability by age
Singles Couples
Source: Productivity Commission and Treasury calculations using Statistics New Zealand Survey of Family, Income and Employment data
Differences between ethnic groups
The capacity to buy a house varies across ethnic groups, and is highest for European New Zealanders and lowest for Pacific peoples (Figure 4.8). This may partly reflect location choices and disparities in average incomes and wealth, with some ethnic groups more likely to be concentrated in Auckland. Reflecting the aggregate results, affordability declined for all ethnic groups between 2003/04 and 2007/08.
Figure 4.8 Affordability by ethnicity
Singles Couples
Source: Productivity Commission and Treasury calculations using Statistics New Zealand Survey of Family, Income and Employment data
Notes:
1. Ethnicity was prioritised using the old Statistics New Zealand hierarchy.
Differences between regions
While house prices in different regions converged to some extent during the recent boom (see Chapter 2), variations in house prices and household composition mean that there are still significant inter-regional affordability differences. The Commission has identified three approaches to measure regional differences in housing affordability, all of which show that such differences do indeed exist. In addition, all of these regional measures highlight low levels of affordability in Auckland relative to the rest of the country. First, Demographia (2011) has calculated the ratio of median house prices to gross annual median household income for eight New Zealand submarkets in 2010 (Figure 4.9). According to these estimates, housing in four regions is deemed to be ‘severely unaffordable’, with a ratio exceeding five (Tauranga- Western Bay of Plenty, Auckland, Christchurch and Wellington). Housing in four other areas was classified as ‘seriously unaffordable’, with a house price-to-income ratio exceeding four (Hamilton, Dunedin, Palmerston North, and Napier-Hastings).
Figure 4.9 Housing affordability median multiple ratings for New Zealand regions, 2010
Source: Demographia (2011) Notes:
1. This affordability measure is calculated using a ‘median multiple’ measure that divides median house prices by gross annual median income. A value between four and five is considered to be ‘seriously unaffordable’ and a value greater than five is considered to be ‘severely unaffordable’ (Demographia, 2011).
Second, as described above, Roost Mortgage Brokers publish indicators that measure the proportion of weekly take-home pay required to service a mortgage across different regions for ‘typical’ home buyers and ‘first home’ buyers.39 In both cases there are large regional differences. For example, the ratios range from 26% in Whanganui to 74% in Queenstown for the typical buyer in October 2011 and from 22% in
Whanganui to 78% in Auckland’s North Shore for first time buyers. Auckland areas are always among the most unaffordable – in October 2011, the typical buyer ratio was 71% for the North Shore, 67% for central Auckland, 65% for south Auckland and 58% for west Auckland.
Third, data from SoFIE indicate that housing affordability is lowest for people living in Auckland, followed by Wellington, Canterbury and Waikato (Figure 4.10).
Figure 4.10 Affordability by region
Singles Couples
Source: Productivity Commission and Treasury calculations using Statistics New Zealand Survey of Family, Income and Employment data