For decades, banks have used a golden rule to determine whether potential mortgagees can afford to repay the house they plan to buy. They use the ‘30 per cent disposable income’ threshold to determine the affordability of purchasing a particular property. This is based on the notion that when spending on housing exceeds the 30 per cent threshold, people do not have enough money left to pay for life’s other necessities.
The widely held belief that young people can no longer afford to buy their first property, despite different incentives offered by banks and the government, has been confirmed by empirical research.
Last November, a report by KPMG found that young single people with an average income were unable to afford 95 per cent of properties on the market. The report also confirmed that a buyer in the late 20s earning a wage of €21,000 – roughly the national average – could only afford to buy a property worth up to a maximum of €171,000.
Still, a report compiled by an architecture and property valuation firm, DHI Periti, concludes that property has become more affordable in the last 40 years. Simply put, the report argues that “comparing housing affordability scores from 1982 to last year shows property in Malta is now more affordable than it was 40 years ago”. So, how reliable are this professional firm’s metrics used to measure affordability?
The affordability index used in most countries uses an old methodology based on the 30 per cent standard. This gives a reasonably good indication of the affordability of a property in the case of a specific prospective buyer. However, it overstates housing affordability challenges in high-cost markets like Malta.
Given its simplicity, it remains a reliable indicator of affordability over time. However, it has various flaws that must be considered to determine its usefulness. The Housing Affordability Index (HAI) that the DHI Periti report is based on fails to account for, or even recognise, any out-of-the-ordinary circumstances currently bedevilling the housing market.
The current housing affordability index ignores key factors like family savings rates, available cash assets, consumer credit, indebtedness, credit servicing obligations and inflation. DHI Periti acknowledges that “property prices had ballooned over the years, multiplying by 16 times the levels seen in 1982 while wages had risen only seven times”.
Moreover, the level of consumption for a household differs according to the number and type of people living in a given household. For example, families with many young children often have higher healthcare, food and child education costs.
Housing affordability experts acknowledge the limitations of the HAI used in the DHI Periti report. In the US, these experts are trying to find better metrics to gauge housing affordability for different types of households. One approach is based on “residual income”. The cost of necessities not accounted for in the HAI is subtracted from a household’s income. This calculation produces the amount and share of income the household members can spend on housing and still have enough left to cover other necessities.
The residual income approach clearly offers the prospect of generating a more precise measurement of household cost burdens than the rigid 30 per cent standard. However, the precision comes with downsides as family circumstances can be so different.
Determining housing affordability must not be based on oversimplified metrics. Neither must it be defined by the happy talk of property market cheerleaders and spin doctors.
Social policymakers must continue to research from different perspectives how property prices are impacting the well-being of society now and in the future.