Beware the illusion of housing affordability

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By Leith van Onselen

The ABC’s Michael Janda has written a solid article today questioning the common claim that Australian homes are at their most affordable level in a decade. From The Drum:

The most recent Housing Industry Association-Commonwealth Bank quarterly Housing Affordability Index for September showed times had not been better for buying a home since June 2002.

With home prices on the rise, deposits losing their relative value, and affordability at a decade high, surely it must be time to jump into the market?

So why then do the most recent ABS housing finance figures for November show first home buyers making up the smallest proportion of new mortgages on record? Why are new home buyers accounting for just 7.6 per cent of real estate purchases?…

The obvious question then is, how can housing simultaneously be … overvalued and the most affordable it has been in more than a decade?

The answer lies in what the HIA-CBA Housing Affordability Index measures, and how it measures it.

It compares the level of monthly mortgage repayments on a median-priced property purchased now with average weekly earnings. The index does so at current interest rates, which happen to now be sitting around record lows…

Over the life of a 25-year loan, it is pretty fair to assume that you will end up paying, on average, the average interest rate, not the lowest rates in decades as we have at the moment…

So, housing affordability over the life of a loan is likely to be pretty average at the moment, relative to very recent history…

What is certain is that Australian housing isn’t affordable unless you’re betting the house on rates staying at record lows for decades, and that’s a very risky financial move – just ask the now homeless honeymoon rate buyers in the US.

Michael Janda’s criticism of the HIA affordability index is similar to my own view, expressed numerous times previously:

…housing affordability (i.e. the cost of the home relative to incomes) and mortgage serviceability (the immediate cost of servicing the loan) are not the same thing. The former has only improved modestly in recent years, whereas the latter has improved significantly thanks to the reduction in interest rates, which are unlikely to always remain so low. In this regard, the HIA’s index should really be labelled a “mortgage affordability index”, since it measures the current cost of obtaining a mortgage on a median priced home, not the structural cost of housing per se.

For what it’s worth, below is my own mortgage affordability index, with median house prices derived from Abelson & Chung (2004) and APM, variable mortgage rates from the RBA, and household income measured as 1.5 times average pre-tax weekly earnings. As you can see, mortgage affordability has certainly improved in recent times, although it remains below the long-term average.

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33 Responses to “ “Beware the illusion of housing affordability”

  1. Ortega says:

    Emergency low rates have simultaneously slammed the savers, whilst pumping the investor specu-orgy.

    So, house prices have risen.

    And the real scandal here, is that somehow, we’ve all come to believe that houses have not been as affordable for a decade!

    What a ruse.

    And what a catastrophic imlosion it will be…. :)

  2. “Afford: To manage or bear without disadvantage or risk to oneself.”

    Michael’s article does a good job of pointing out the risks (what happens when/if rates normalise).

    What about disadvantages…

    More First Home Buyers are deciding to buy a unit instead of a house
    First Home Buyers are spending more time commuting to and from work

    http://www.digitalfinanceanalytics.com/blog/first-time-buyer-life-style-trade-offs/

    • Lori says:

      And does anyone realize that if the mortgage payments now are 45-50% of household income, which means 45-50% of two incomes, that if one of the partners gets pregnant, or look after a child or gets seriously sick, or gets unemployed, that means the mortgage payment automatically becomes 90-100% of household income?
      Obviously math education in Australian schools is at very low level.

      IS THIS AFFORDABLE?

      • PhilBest says:

        Uni Prof. Elizabeth Warren became a YouTube sensation and got elected to the US Senate by pointing out the fact that while global capitalism has brought down the cost of food, clothing, appliances, cars and mobility, and a lot of discretionary items, somehow “housing” now swallows a higher proportion of double incomes than it swallowed of a single breadwinner’s income in 1970.

        I think she is dead from the neck upwards about the role that urban planning has played in this, but she makes a LOT of good points about the consequences:

        “The Coming Collapse of the Middle Class”

        http://www.youtube.com/watch?v=akVL7QY0S8A

        The “savings” (in food, clothing, appliances) have been in low-proportion and “discretionary” spending items. The big increases have been in “basic” and unavoidable expenses. In fact, I would like to inform her that when there is a successful closed-loop land-rent-extraction effect at work in the urban economy, savings made in other areas will be sucked up in increased cost of urban land.

        Single-breadwinner 2-parent families in the 1970’s made less money, BUT “big basic expenses” absorbed 50% of their income, while the 2-income household now needs 75% of their combined income to meet these costs, and have less discretionary income.

        The typical household now is at HIGHER risk – if one earner loses their income or some of it. The 1 earner household had the chance of the non-working spouse adding a little income in times of stress; or even becoming the main breadwinner (as many widowed and separated women did). But now? Both adults are already fully committed and there is no slack able to be taken up.
        Elizabeth Warren presents some very interesting breakdowns of data. Income volatility is higher for everyone now than it used to be, but is highest of all for two income families.

        Housing cost for families with no children, is up 50%; for families with children, it is up 100%, obviously representing the need for more space.

        There are more children in bankrupt households, than in divorced households. 85% of bankrupt households successfully hide the fact.

        The households who are fortunate enough to get through life without suffering a reversal (health, accident, job loss) will probably “make it” without dropping out of the middle class. but even so, will never get security, and are always on the treadmill, in contrast to their parents (1 income earner) generation. Everyone who does suffer even one significant reversal drops, most likely permanently, into the bottom class.

        As Hugh Pavletich calls it: the bankers benefit scheme; women becoming mortgage slaves along with their husbands. Pity about the collateral damage, eh?

      • OMG says:

        Nobody put a gun to their heads

        Growing up in the 80s I can recall half the mums in the neighbourhood were home during the day (parents would usually know who was home and tell their kids to seek help from such and such is something happened)

        Slowly these mums made their way into the workforce (not due to mortgage repayments but to get ahead).. they knew that two incomes would help them buy a better/bigger house or help them save for that inground pool

        They still had the choice to sit at home, these homes were purchased a decade prior in the new estate for around $30k which was about what the average factory worker was making then, so mortgage repayments were not an issue.

        Now things are cheaper than ever so not surprisingly we have more money/ability to borrow to plow into that new house

        Cars cost what they did 20 years ago, washing machines and TVs cost less, a VCR would have cost $450 in the 80s, now you can get a DVD player for $19

        So people had a choice, buy 22 DVD players or invest more into their homes, what did you expect them to do

        Is it affordabile? Nothing suggests that it isn’t

  3. Coming says:

    Would it not be calculated based on fixed interest rate loans available?

    Which are obviously not fluctuating once locked in…

  4. squirell says:

    … and even more importantly
    a) household income now includes 2 incomes for the most part, and not always out of choice. EVERYTHING becomes more affordable if you work longer hours, and they would become even more affordable if you sent your kids out to earn money for the family
    b) the “median” house is no longer a 600sqm block 10 ks from town and close to transport and schools. I’d say its further out and maybe been subdivided.

    so in other words, despite low interest rates we are working longer to get less.

    • Lori says:

      I think they will count 3 incomes in the near future as the parents are more than ever expected to take part in the slaughter.

  5. Jordan@ABC says:

    Fantastic article, this discussion came up on Twitter yesterday, not surprisingly a lot of opinions out there.

    wrote a similar article looking at rates over the last 30 years (seeing that’s how long people would have a mortgage for), and told through the lens of the average Aussie couple, using some assumptions about discounted rates going back that period

    http://www.abcbullion.com.au/site/assets/media/Housing-Affordability-in-Australia.pdf

    Bottom line, Michael is spot on.

    • Lef-tee says:

      Good article Jordan.

      I can only add that I think the situation may be potentially worse than that for many since I am quite convinced that the ABS overstates the average wage for statistical reasons that I can’t quite fathom. The only young prospective first home buyers I know with $140 000 a year take home pay have one partner earning mining sector wages. I may be remembering it wrong but last I looked, the ABS seemed to think that the average shop assistant takes home over a grand a week net of tax. That is grossly innacurate on the high side.

      • Jordan@ABC says:

        You’re probably right Lef-tee, but i wanted to use official statistics as the situation is damning enough there, and then can’t have anyone claiming i’m using made up numbers.

        Could be wrong but i think the ABS numbers include superannuation too, which whilst a part of total REM, obviously can’t go toward the mortgage or other expenses.

        Did you see the articles today posted about how much further FHB’s are commuting to work in the last few years??? i think an extra 40 minutes a day. Thats over 3 hours a week lost, time you could be working earning more $ of spending with kids etc.

        One word for this and it is tragedy!

      • PhilBest says:

        Jordan, that is well spotted and absolutely true.

        That is another unintended consequence of inflated house prices. See:

        http://www.newgeography.com/content/003849-portland-s-transit-halcyon-days#comment-23607

      • steve99 says:

        Absolutely true. I know one large outer suburb of Melbourne (Cranbourne to be exact) whereby if you ring fenced it and then worked out the median (not average which is often overused to show affordability) for this area and many others like it, you would find that the median wage would be around $30k or so pa. This taking into account that many full time jobs enjoyed by workers in the bottom 1/3rd of the workforce are getting paid around $40kpa and lots of other workers are scratching by on part time casual jobs or even the dole. The current trend in the media (spruikers of course) is to state some insane ‘average’ income and then compare it to the cheapest houses being built in these outland suburbs, currently around $400k which just happens to be 10x the areas median gross full time wage. Traditionally house prices reflected the affordability as seen by the workers in a particular area but to look at todays scenario with any grain of common sense all that can be seen is madness.
        It is speculators alone which are buying up these areas en mass and from what I have seen are turning them into semi ghetto’s with every second house rented out and becoming dilapidated. Take these parasites away and the false demand would drop and perhaps pricing would reflect real affordability.

    • Mark Out West says:

      @ Jordan

      The thing is us boomers didn’t see going on O/S trips annually as an option. We had one telephone, fixed line, we didn’t have gym memberships. Child care subsidies weren’t available so you paid the full amount or someone gave up work.

      We also didn’t have the deflationary electrical items from China, I paid $450 for a printer in 1985 and $350 for a drill you get for $120 now.

      These interest rates are the new norm.

      We knew that we had to forgo stuff to support the family X & Y think they deserve it all NOW.

      • drsmithy says:

        We also didn’t have the deflationary electrical items from China, I paid $450 for a printer in 1985 and $350 for a drill you get for $120 now.

        Yeah, saving a few hundred dollars on purchases you only make every half decade or so sure helps offset having to pay twice as much mortgage payment every week !

      • Jordan@ABC says:

        Hi Mark Out West

        thanks for the reply, and to others who obviously read the link. Always good to have this debate.

        Mark, in response to your thoughts – my feelings are as follows.

        Firstly, you are correct that the price of many discretionary electronic goods, machinery etc have fallen a long way, i can remember getting a cassette player for Xmas in the 80′s and i think it set Dad back like $200 (crazy stuff), but at the same time there’s a whole lot of stuff that has gone up in price a lot more.

        You are also right that my Scott and Charlene couple could get rid of the gym membership, and in all likelihood they won’t have a home phone but rather two mobiles. They could also not have an annual holiday, saving them $5k, and as for childcare, you are right, they don’t need to spend on it, but as you say, there goes one wage as well (note childcare fees are skyrocketing in Aus btw, so the rebate/subsidy does little to help here).

        But, and here is the really important thing and has nothing to do with Gen Y wanting it all now vs Boomers who sacrificed (as we’ll all have differing opinions on that), lets work through your logic, if i may.

        Charlene says i can do without a mobile
        Scott cancels his gym membership
        They don’t go on an annual holiday
        They cut their discretionary spending even further (from say $200 a week each to $150 a week)

        Well – what just happened to the Aussie economy

        Optus lost a mobile phone customer. Fitness First lost a member. Virgin Australia or Jetstar sold 3 less return tickets for the year, Hertz got one less car rental, a hotel missed out on 4 nights accommodation, some restaurants missed out diners eating out, and their $50 a week cut in discretionary spending means the pub is now selling a few less beers and the coffee shop a couple less lattes

        Bottom line. Sales around the country fall, as does employment, and the economy slows down further.

        And then what happens?

        Joe Hockey or whoever is in charge announces emergency spending measures, which = debt, which the younger generation will have to service, and, lo and behold, the RBA responds to domestic weakness by you, guessed, cutting interest rates further.

        And then what happens?

        Those who have wealth, quite justifiably look for a better home for their capital than a term deposit paying 1-2%, and they buy Australian property, pushing house prices even further up, meaning those who are 2 years behind Scott and Charlene need to ‘cut-back’ even more.

        This is the dead end road we are on in this country, and as painful as the ‘day of reckoning’ will be, the more we delay it the worse it will become.

      • pingupenguin says:

        @Mark Out West

        That is the biggest load of bullshit ever. Is the couple of thousand I might save on a gym membership and an iPad going to make the difference between owning a house or not? My yearly savings dwarf those “luxury” gadget/lifestyle items by an order of magnitude. Giving up an iPad isn’t going to drastically increase my deposit.

        I don’t go on annual overseas trips and don’t go on luxury local holidays. When my wife wasn’t on maternity leave we would save 1 whole income for our deposit every year. But when houses prices are rising so fast that a professional couple has to borrow half a million just to get an apartment in the same area we grew up something is seriously wrong.

      • flyingfox says:

        @Jordan@ABC

        So very well put. Imagine if homes cost $100K and has no investment potential. How much would other sectors flourish because of this?

        No need to have 100K wages either …

      • Mark Out West says:

        @ Joradn

        We are talking about housing affordability.

        If you are a gen X / Y couple you have a $100 a month mobile phone bill. Get a landline like I had and save $70.00 a month.
        Get rid of the Gym membership at at $50.
        The O/S trip at a cost of $30.00 a month.
        Internet connection $30.00 a month
        Then there’s the cost of fitting the house out, my guess I paid $1200 in today’s money for my printer in today’s money. All goods now are much cheaper. Lets say you fitted out the flat circa 1982 with 20 inch colour television etc and you would save into today’s money $10000. Car shave never been cheaper even with all their features and way more fuel efficient.
        The misus was working at the time but because there was no subsidised childcare she had to leave work.
        Let’s look at your missus wage that would be 40% better, due to wage equality, than mine for doing the same work (accounting).

        Due to subsidised childcare your missus can reenter the work force much quicker and will be paid much better than mine. Your missus will dependent on the organisation be offered a part time job and gradual integration.

        Take the $250 a week and pay down your principal now and you guys NOW ARE WAY IN FRONT.

        The rest about impacts on the broader economy seems misplaced when you read the post from the obvious X/Y who are buying O/S, it seems your gen are the ones with the least invested in the broader economy.
        It is only here on these blogs that I encounter the sentiment “F*CK this place lets piss off “.
        I’m not advocating that the RE is not a leach on the butt of society, but that it has always been so.

      • avatar99 says:

        Mark Out West, your logic is flawed. Just because it was hard to buy a house 20 years ago doesn’t mean it it not harder now. It was emphatically NOT “always been so”. Things are worse now by almost any objective measure. Also, although I’ve seen plenty of people state the X&Y want it all now I have never seen anyone cite any fact to corroborate this claim – do you have one, or it is just something you feel must be true? Did you see those commute numbers on the recent post here on FHB’s? 160 mins per day commuting is completely outrageous – hardly something undertaken by a whiny want-it-all-now.

      • steve99 says:

        The reality is that, of the things you absolutely need, shelter, utilities, food and the money to pay for it, only food is cheaper or the same as back in the day and the money to pay for it, is not as secure as it once may have been. As for housing it its so far out of whack as to be on another planet. (cars, discretionary toys and travel are of course much cheaper)
        ps, I am a tail end BBoomer so do know the difference, unlike most people of any age though I can and do think things out at more than one level whereas the current debate tends to be tit-for-tat, dog like, you got a biscuit, I didn’t so therefore Im going to bite you, not the distributor of the biscuits.(ie government and its policies)
        What I have noticed though is that at all times in history, most people have to hand over most of their pay in order to live, whether its 1/2 your pay in food as it was in my grandparents(in the UK) day. or in paying a massive mortgage, ‘THEY’ will always find ways for you to spend it all and at the same time deviously work out ways and means to stop you from becoming secure in life, ie casualisation of the workforce, offshoring jobs, mass immigration ( all globalisation of course). Only a small hand full of people beat the organised system. (maybe 20% of baby boomers did, certainly not all)

    • PhilBest says:

      Excellent assessment, Jordan. Young people have been very badly advised by their elders; and now finally the situation with house prices is so bad they can’t even take on the colossal risk at all, that young FHB’s have been up to recently.

      What so many well-meaning older people forget, is that when they “ad it tough” with the mortgage in their day, that involved a high interest rate but a relatively small mortgage principal. Along with interest rates being high, so is inflation. So incomes were rising, inflating away the impact of the mortgage, both its principal and the repayment burden. Some people experienced a 100% increase in incomes over 7 years in the 1970′s. That did wonders for the burden that the mortgage represented.

      AND as soon as inflation was tamed, the interest rates come down……!

      The current generation is very unlikely to be this “lucky”. Even if we are in for very high inflation whereby annual incomes will be several million dollars within a few years. Meanwhile, the effect of interest rates going up – which they certainly would – would be a lot more harmful than it was for anyone who at least bought a home with a moderate principal relative to income. The size of the principal relative to income is a real killer in “future scenarios”. If you borrowed 2.5 times your income at 10% interest and the rates went up to 20% you would be in trouble, but your income would be growing at close to the 20% due to inflation/wage round mandates from government. After 7 years of this your income would be equal to your mortgage principal and 20% interest on that would be quite manageable again. After the first year, your mortgage interest would be close to 1.8 times what it was relative to your income.

      If you borrow 5 times your income at 5% interest and the rates go up to 10%, you are in just as big trouble and your income will NOT be rising to inflate away the principal anywhere near as fast. So you are a lot more vulnerable for the following few years. After one year your interest payments will be close to 1.9 times what they originally had been, and it will take twice as long for the relief effect to work.

      And we need to add back to these comparisons, the larger (presumably) repayments of principal. And if the rates go up to 20% you are probably bankrupt that year – the result would be mortgage interest payments close to your entire annual income.

  6. Hugh Pavletich says:

    The HIA … When will they ever learn ? …

    Report: Housing Affordability Out Of Sync With Incomes …

    http://news.domain.com.au/domain/home-investor-centre/report-housing-affordability-out-of-sync-with-incomes-20110202-1ad3m.html

    The Demographia Survey is out Monday. Lets see then !

    Hugh Pavletich

  7. DMc says:

    “The index does so at current interest rates,…”

    Which interest rate do they use? I assume it’s the average standard variable rate of the big-4, is that right?

    Surely they should be using the 25-year fixed rate if they are assessing repayments on a 25-year loan.

  8. PhilBest says:

    Seeing the spruikers love “mortgage affordability” measures; Leith, why don’t you call their bluff and do a “mortgage affordability” index for some US cities?

    Imagine how much of a massacre it would be of the Australian claims to “affordability”, given that they have record low interest rates AND the prices are still at around median multiples of “3″.

    • Rusty Penny says:

      Yeah, I would have thought ‘affordibility’ would at least comprise paying the capital back.

      Not how much of this fortnights pay cheque does it consume.