Are current measures of housing affordability fit for purpose?

 

Opinion piece by Dara Turnbull, Housing Europe Research Coordinator

So, how do we currently measure affordability?

Probably the most commonly used measure in the EU, at least in terms of comparing one country to another, is the “share of housing costs in disposable household income” measure produced by Eurostat as part of the annual Survey of Income and Living Conditions.

There are a number of issues that using this measure of affordability presents in practice. However, we will quickly review just three, namely: 1) the exclusion of the repayment of the mortgage principal, 2) the decontextualisation of disposable income and 3) the capture of those excluded from the housing market.

The Mortgage Principal Problem

When you borrow money to purchase a home, the money borrowed is called the principal. It must be repaid to the financial institution from which the money has been borrowed, along with interest. Bizarrely, the EU-SILC data exclude repayment of the principal as part of housing costs. This likely reflects a desire to not ‘distort’ the national picture as a result of idiosyncratic differences between countries and households within those countries. For example, if you and I purchase an identical house for the same price at the same time, but I chose to repay the mortgage over 20 years and you choose 30 years, it would appear my housing costs are higher than yours.

Assuming that Eurostat excludes the principal for this reason, it would surely be better to produce two sets of housing costs figures, one which includes repayment of the principal and one which doesn’t. To exclude it entirely gives an artificial picture of affordability, especially when comparing a country with a high percentage of mortgage holders to one with a low percentage.

The Disposable Income Problem

In its simplest form, disposable income is equal to (earnings + social transfers) – (taxes and social contributions). Effectively, it is the bottom line of the payslip of an ordinary worker.

So, how does this cause an issue when it comes to the use of the overburden rate? Well, quite simply, what a person in one country will need to ‘purchase’ with their disposable income may be completely different to what a person in another country will need to purchase. A country in which taxes on personal income are high, but where benefits and services delivered by the state are also high will, in theory, require a lower disposable income , as expenses such as healthcare, childcare, education and transport are already provided fully or at a subsidised rate.

Overall then, disposable income presents an interesting conundrum. Its importance to the assessment of housing affordability in the SILC figures means that we may risk comparing national figures in a way which fails to control for different cost-of-living issues. However, it seems hard to argue that any meaningful assessment of housing affordability will not need to include a measure of income somewhere (more on this below).

The Exclusion Problem

The final issue that we will look at (though there are certainly others), is exactly who is captured in each household and how. For example, figures from Eurostat show that there are approximately 50.2 million 18-34 years olds in the EU still living at home with their parents. This distorts our view of affordability in two ways.

Firstly, if a young person is living with their parents, but also working, then their income is included as part of the income of the household. Thus, it increases the disposable income of the household, while also giving the impression of greater housing affordability. This may be the case if the child makes an equal financial contribution to the running of the family home, though in practice, the focus may be on increasing their savings with the hope of moving out.

Secondly, if a young person is unable to move out because they are unable to afford to access housing, then clearly housing is unaffordable for them, but this is not being captured in the figures. Thus, perversely, high exclusion rates may actually help to weigh down the housing costs to disposable income measure. A similar argument can be made for those living rent free in housing provided by family or friends or those experiencing homelessness.

Moving Forward

There are of course other measures of housing affordability which exist, though they too have flaws. Some ideas on how we might improve on the abovementioned metric though are:

• Include the mortgage principal in housing costs.
• Better capture national cost-of-living issues by using disposable income minus essential non-housing living expenses. This is often referred to as the ‘residual income’ approach. It will serve to level the playing field between countries with high levels of public led service provision and others.
• Provide notional measures of housing costs to (residual/disposable) income based on the average and median earnings of different groups in society (age, gender, nationality, etc.). This will allow those excluded or hidden from view in the SILC data to have their difficulties in accessing housing more clearly seen

In the long-run, Eurostat should move towards producing a more all-encompassing or holistic measure of housing affordability. One which adequately captures the issues mentioned above and others like them. The very successful ‘Human Development Index’ produced by the United Nations seems to offer a straightforward template. Thus, perhaps it is time for an EU-wide ‘Housing Access and Affordability Index’.