Forget affordability measures and ask yourself some tough questions
There are many measures of affordability in the marketplace, sadly I believe that many of these measures fail to accurately depict the affordability or otherwise of housing in Australia.
The main reason being that housing affordability is an extremely complex issue and many factors drive the affordability of housing. In my future posts I am going to investigate some of these factors and tell you what you should really be asking yourself about affordability when purchasing a home.
Can I start by stating that simplistic means of comparing property prices between countries I believe are ineffective.
Due to different tax regimes, standards of housing and attitudes to property and wealth accumulation there may be perfectly good reasons why a household is prepared to spend more on housing in Australia for example than they are in the United States. I think common measures such as the median multiple (ratio of household income to property prices) are not necessarily a good way to measure affordability or otherwise, there are a lot more factors at play.
Interest rates
Interest rates are obviously an important component in determining housing affordability. When interest rates are lower, interest repayments on home loans are lower and as a result ‘affording’ the repayments on a mortgage should be easier. Of course, as we are seeing at the moment, lower mortgage rates often encourage higher property values.
So while it’s true that lower interest rates make housing relatively more affordable, if values are rising and sales increase then it can somewhat off-set the affordability benefit of lower mortgage rates.
Furthermore, the typical home loan in Australia is 25 years and the vast majority of home loans are on a variable rate. As a result, as the Reserve Bank adjusts monetary policy there is virtually an instant effect on household budgets and balance sheets. For example, at the moment the standard variable mortgage rate sits at 5.95% however, over the past 10 years the variable mortgage rate has averaged 7.27%, over the last 20 years it has averaged 7.45% and over the past 25 years (the typical home loan length) it has averaged 8.47%. Over the past 25 years, standard variable mortgage rates have been as high as 17.0% and as low as 5.75%.
The point is that interest rates can vary greatly over 25 years and over the life of the loan the current interest rate is not a great means of measuring the cost of a mortgage over its lifetime.
Wages / Income
If you are going to take out a mortgage on a home (as most purchasers do) you are going to need an income and you are going to need some savings. In Australia there are a number of measures of wages/income and it is difficult to know exactly which one is best to use to measure housing affordability.
The National Accounts measure the ‘Real net national disposable income – chain volume’. This measure does have a number of shortcomings in that it is not an individual measure and that it includes items that one can’t really spend such as superannuation. Additionally this data is only available from a national standpoint.
The Australian Bureau of Statistics (ABS) publishes its wage price index each quarter however, it measures wages only and doesn’t measure income captured from other sources. The Census is undertaken each five years and does report on the median weekly household income however, the shortcoming here is that it is only updated every five years.
We also have the Household Income Survey from the ABS however it is only undertaken bi-annually and takes a fairly macro view of household incomes
Unfortunately all of these measures have significant shortcomings which need to be considered when looking at any housing affordability measure.
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Labour force / unemployment
Paying off a mortgage eats up a significant portion of a family’s wage. Undoubtedly if home values weren’t so high and mortgages weren’t so large disposable incomes would be much greater. Although labour force data or unemployment statistics need not necessarily be an input into any housing affordability measure they are a key consideration for someone looking to purchase.
The threat of unemployment means that despite the fact housing may seem affordable it is less likely someone would purchase. Obviously if you are unemployed it is going to be difficult to purchase a home.
Another factor to consider is although measures of income show that over recent years wages and disposable income have increased, what they don’t take into account is how many more women are working nowadays. Labour force data shows that in May 2014, 54.1% of the workforce was male and 45.9% was female, 30 years ago 62.3% was male and 37.6% was female. Today, 35.5% of full-time workers are female compared to 28.9% 30 years ago.
The point here is that although household incomes have increased, a big proportion of the increase is due to the structural change associated with a greater number of women in the workforce.
The rising prevalence of dual income households means that whereas 20 to 30 years ago couples could afford mortgage repayments on a single wage, today they largely require dual incomes.
Home values / prices
Most measures of housing affordability look at median prices or median values.
The important thing to remember here is that a median is just the middle value so there are just as many homes worth more and less than that figure. In fact the median price looks only at the middle value of properties which have sold over a period.
This obviously has significant shortcomings because what is predominately selling could be at the affordable or expensive end of the market and this could bias the median one way or another. Remember that typically only 5% to 7% of total housing stock transacts in a given year.
Another important consideration here is that a national median measure doesn’t really tell you very much at a localised level. In Australia, 66% of residents live in a capital city with around 55% in Sydney, Melbourne, Brisbane or Perth.
Quite simply many residents don’t have a choice but to live in a capital city so if you are trying to determine affordability in Melbourne, the cost of housing in Mildura is of no valuable comparison whatsoever.
Rental rates
If you don’t own a home or pay-off a mortgage you have to live elsewhere, for the most part non-homeowners rent. The cost of renting is an important consideration when trying to determine housing affordability. If rents are increasing but home values are flat or falling purchasing a home may start to look a more attractive prospect.
Once again the challenge with a measure which compares rents to house price (or mortgage repayments) is that it is not a localised analysis. For example for the cost of renting in Paddington in Sydney you may actually be able to pay off a mortgage in Guildford but to the renter is the opportunity cost of owning their own home and being further away from the city centre, harbour and the beaches worthwhile?
Who knows but for anyone looking to purchase these are the sorts of questions they need to be asking themselves.
The other key consideration is that the ongoing costs associated with owning a home as opposed to renting are difficult to determine, but they are much more than renting. As a renter, the ongoing costs generally include: the rent, the bond, electricity, gas (if applicable), cleaning (if you move rentals) and the cost of moving if/when you move.
As an owner of a home the costs incurred include: the mortgage, electricity, gas, council rates, stamp duty when you purchase, ongoing maintenance of the property, strata fees (if you own a unit) and agent fees if/when you decide to move. The ongoing costs associated with owning a home are much greater than the ongoing costs of renting.
Who does housing affordability affect most?
Housing affordability affects everyone. The high cost of housing acts as a disincentive for people to move to more appropriate locations, discourages people from upsizing and downsizing and discourages movement intra or interstate for employment. The group most affected by housing affordability however is those who don’t as yet own a home.
Again if we think about many of the measures of affordability used they look at typical or median prices values and compare to interest rates and typical wages. The problem with this approach is that very few people are actually typical. As a generalisation, most people that rent are younger, starting out their careers.
There is a high likelihood that their wage is currently lower than the median (although there is a good chance it will increase as they are promoted or move jobs). If their wage is below the typical wage then they should not be looking to buy the typical (or median house).
Of course there are plenty of renters that earn above average wages but choose not to purchase as well but when trying to tackle the affordability question I think many of the measures that we look at are far too simplistic, but hamstrung by the quality and granularity of income data.
Housing affordability is an individual thing and none of the measures really tell the true story about how affordable or unaffordable housing in Australia is. When determining whether you can afford to buy a home I think the most important things to consider are:
- What are current mortgage rates and at what higher level would I not be able to repay my mortgage?
- How secure is my job and what would happen if I was to lose my job for an extended period?
- Over the next few years what is the realistic expectations for my wage, will it rise and by how much?
- What impact would it have if I found a partner or lost a partner on my ability to repay the mortgage?
- If I plan to have children, children cost a lot what impact would that have on my ability to repay the mortgage?
- Compared to my current rent and associated costs, how much more is paying off a mortgage and the other day-to day costs of home ownership really going to be and can I afford this?
- What am I willing to sacrifice in order to buy a home; lifestyle, location, overseas travel etc? What is the opportunity cost of buying a home?
I am sure there are many more questions to ask when looking to purchase but I think as a start these questions are essential. I say that the measures of affordability which are readily available should be taken with a grain of sale.
It’s more important to ask yourself some tough questions about whether or not you can really afford to be a home owner. If you have any doubt you really need to consider whether it is worth the risk or not.
For what it’s worth, I think that housing affordability is a significant issue for young Australians, particularly those within our capital city markets. he major problem is that most Australian’s choose to build wealth through property and 23 years of unabated economic growth has on exacerbated this.
The challenge now is how can you deliver affordable housing for younger Australians without bringing down the cost of existing housing which politically and economically would be detrimental to the overall health of the Australian economy.
