Exploding the myth of housing affordability

Almost every year, with monotonous regularity, I have read headlines declaring how unaffordable Australian housing is.

The only clear function the statement seems to serve is to capture readers’ attention in newspapers.

The first challenge lies in trying to work out what the statement even means.

The 2014 results of an international housing affordability survey have only recently been released.

The report ranks 360 metropolitan markets in nine countries in terms of affordability. It uses a formula known as the “median multiple”, where the median house price of a market is divided by the median household income for that market. According to the formula, any city that results in a score under 3.0 is considered to have housing that is affordable, while anything over 5.0 is severely unaffordable.

In the latest report, the median multiple for Melbourne was 8.4 for 2013 (an increase from 7.5 in 2012). This means that the median house price in Melbourne was 8.4 times the median household income of people that lived in Melbourne.

To consider Melbourne as one property market, however, is meaningless. The price and performance of a studio apartment in St Kilda is different to a riverfront property in South Yarra, which is different to a three-bedroom home in Ferntree Gully, or a two-bedroom unit in Essendon. Similarly, the demographics and economic profiles of residents in each of these locations varies considerably.

People often move to a city – and for larger population centres such as Melbourne, within the city – for greater opportunities, most usually economic or employment-related. As more people move to a specific location for work, household income increases as a result of increased wages, and the demand for housing also increases. Those who are in lower income levels get squeezed out of that market. This is nothing new.

Cities like Melbourne, however, are not isolated. They are truly global cities. Melbourne and Sydney should be compared with Hong Kong, New York, Paris, London, Vancouver and Los Angeles – all global cities as well. When property performance is compared between these cities, they all behave in the same way. As the world becomes more globalised, the result is greater access to local real estate market conditions around the world, resulting in metropolitan housing markets becoming more attractive to global buyers.

So the price of properties in global cities should be measured in relation to global incomes – not the household income of a resident of the suburb where the property is located. To measure affordability in these terms has no relevance, and reflects outdated 20th century thinking.

The second problem is the formula itself – the formula is basic to the point of being meaningless, and deserves to be challenged. Determining housing affordability is more complex than a simple income to price comparison.

What is the relevant connection between the two factors?

In a practical sense, given that most people do not pay cash for their houses, it is mortgage affordability that is the more pragmatic measure.

When a homebuyer considers buying a home, they look at the price of the home. But that should be at best only one factor in determining whether the property is purchased.

In a very pragmatic sense, the buyer is just as focused on two important questions:

1) How much of a deposit do I need?

2) How much are the repayments on the mortgage each month, and can I meet these repayments comfortably given my ongoing commitments?

In many ways, the purchase price of the property becomes irrelevant.

So any formula should best reflect mortgage payments as a percentage of the buyer’s after-tax income.

Instead of theorising about why or even whether property is so unaffordable, perhaps a better question to ask is what can be done to help people buy their first home.

Governments and banks hold the answers to this question. Assistance with deposits is an obvious start, and the availability of the First Home Owner Grant and associated state-based grants gave first home buyers specifically the deposit help they needed. First Home Saver accounts were a meritorious initiative but the response from savers was poor. Downward pressure on interest rates is also obvious.

Innovations to lending policy such as high LVR loans, loans with a 40-year term and shared equity mortgages are all possible solutions that should be constantly under review.

When considering the “affordability problem”, by far the biggest problem is aspirational buyer beliefs regarding what they feel they are entitled to. We do not have an entitlement to own a home. It is not a right. The belief that we are all entitled to own a home is a dangerous assumption, and has not the slightest merit.

The fact that houses continue to sell at or above asking prices and demand remains strong is evidence enough to refute the claim of ‘unaffordable housing’.

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Troy McErvale

Troy McErvale

Troy McErvale is the founder and managing director of Freedom Home Loans and My Personal Lender, a combined mortgage broker and mortgage management business in Australia, started in 2001. Since 2010, the company has offered an expanded service to include mortgages for foreign owners of US property, as well as US property consulting services to high-net-worth clients.

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