Yesterday’s post considered the recently released Demographia survey on housing affordability. Thanks to everyone who commented; the discussion was useful for honing my thoughts on follow-up posts. Such as this.
But first let’s re-cap: Demographia’s key findings were 1) New Zealand has increasingly unaffordable housing and 2) this is the direct result of urban containment policies.
The main issue I took with the Demographia report in yesterday’s post was 1) the lack of strong economic justification/references supporting their housing affordability indicator of choice (namely the median-multiple ratio) and 2) the lack of discussion/investigation of potential alternative indicators.
Indeed, my quick web search threw up at least two alternative indicators of housing affordability, namely the rent-multiple ratio and the home affordability index, neither of which appeared to lend much support to Demographia’s findings. Of course, this does not prove their conclusions are incorrect, but it does suggest they are premature.
In this post I wanted to look beneath the hood of Demographia’s housing affordability indicator a little more. The reason being that when you do you start to see what they are measuring and, perhaps more importantly, what they are not measuring. In Demographia’s case, they calculated their housing affordability indicator as follows:
Median-multiple = median house price / gross median household income per annum
This then measures, in a simple sense, the cost of the median home relative to the median household income. While that may sound reasonable enough on the surface, the devil is in the detail. Two of the more obvious issues with Demographia’s indicator that spring to my mind are discussed in the following paragraphs.
Demographia’s definition of “income” excludes taxes and transfers. This is pertinent for at least two reasons:
- First, some taxes have direct impacts on property prices, e.g. local rates. These will simultaneously tend to affect property prices (higher rates = lower property prices) and post-tax income (lower), but not gross income. Somewhat perversely, this would mean that jurisdictions with higher property taxes would tend to exhibit more affordable housing, at least according to Demographia’s indicator.
- Second, most taxes directly impact on a household’s disposable income and in turn affects their ability to afford housing. In New Zealand tax rates have changed considerably over time, especially for different segments of the population. Consider for example the impact of Working for Families on demand for certain types of housing.
Such issues mean that the median-multiple housing affordability indicator, as it appears that Demographia have applied it will not pick up on relevant differences in taxes and transfers, both spatially and temporally.
The spatial differences are likely to be fairly minimal within a country like NZ – where local taxes don’t vary that much from place to place – but this is certainly not the case when making international comparisons. Many countries have much higher rates of property taxes (and even local income taxes) that will tend to impact on house prices and thereby affect their housing affordability relative compared to New Zealand.
On the other hand, the temporal differences introduced by changes in domestic tax and transfer policies are likely to be fairly large, even within a country. The potential impacts on housing affordability of recent tax changes to the top personal tax rate, ability to claim capital depreciation on properties, and commercial tax rates are hard to predict in advance. Tax impacts may well spill over national boundaries as well; NZ’s lack of capital gains tax, for example, is frequently quoted by my Australian colleagues as a primary driver of their decision to invest in New Zealand’s property market.
These issues would make me extremely cautious about drawing broad, sweeping conclusions on trends on housing affordability both within and between countries simply based on the median-multiple indicator.
“C is for cookie and that’s good enough for me” – The following (deliberately facetious) statement helps I think to highlight a dimension of the housing affordability debate that is all too frequently glossed over, namely:
You don’t measure the affordability of cookies based on the cost of buying the cookie factory.
The point is that housing is a actually a type of good, or more specifically a service, which is “produced” by a house. You can gain access to housing without necessarily buying the factory that produces it, i.e. rent a house. Obviously, some people do this already and they’re called “renters.” Like me.
Even in New Zealand many people rent by choice. And in many countries in central and northern Europe renting is even more prevalent. But the key takeaway message is that the affordability of housing, which is what Demographia sets out to investigate, is probably better measured (from an economic perspective) using rents rather than house prices. This is especially true for low income households that are more likely to rent.
And that’s why I’d place more emphasis on the graph produced by the Productivity Commission, which calculated the ratio of rents to household disposable income over time than the median-multiple indicator presented by the Demographia study. This showed the rent to income ratio in New Zealand declining since the 1990s, contrary to Demographia’s findings and casting some not inconsiderable doubt on their conclusions.
My preference for using rents is also related to the first point on the impacts of taxes on house prices: Unlike houses, which are an asset, rents measure the cost of housing services. I suspect it’s far easier to “net out” the impact of services taxes in various jurisdictions, i.e. GST, on rents than it is to adjust for changes in the myriad of other income and asset taxes that might affect house pricing.
That’s all for tonight, but tomorrow’s another day and I’m already fomenting ideas on the next Demographia post; in the meantime I’d welcome your comments/suggestions/criticisms.