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Housing Affordability

Article · July 2012

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David S Bieri
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Abstract
Housing affordability broadly refers to the cost of housing services and shelter - both for renters
and owner occupiers - relative to a given individual’s or household’s disposable income. While
there is no universal definition for this term, housing affordability is an easy concept to grasp
in general. At the same time, affordability can be hard to pin down in practice, especially in
terms of defining the appropriate geographic scope for housing markets, suitable definitions
of representative reference individuals and households, and their changing circumstances over
time. In its most crude form, housing affordability simply refers to the rent-to-income ratio or
house-price-to-income ratio; more sophisticated measures of housing affordability consider (i)
how much nonhousing expenditures are limited by how much is left after paying for housing
or (ii) in addition to “income affordability”, they distinguish between “purchase affordability”
(the ability to borrow funds to purchase a house), “repayment affordability” (the ability to
afford housing finance re-payments). Over the last three decades or so, policy makers have
increasingly begun to frame discussions of the availability of adequate housing opportunities
in terms housing affordability as opposed to the more traditional notion of housing need.
Keywords: Housing affordability, quality of life, amenities, local public goods, locational
efficiency, cost of living.
JEL classification: Q5, R2, R3

1. Overview

While housing is often the largest expense most families face, concerns over its afford-
ability have traditionally not seen commensurate reflection in national public policy debates.
For most of the post-war era, national welfare policies were predominantly focused on other
welfare programs, such as social security or health care. Indeed, in most developed countries,
housing affordability has joined more traditional housing issues such as fair housing access
and substandard quality units as a focal point of discussions about housing policy only since

I
Entry prepared for the forthcoming Encyclopedia of Quality of Life Research, New York/Heidelberg: Springer
Verlag, edited by Alex C. Michalos. The usual disclaimers apply.
∗
Corresponding author: Assistant Professor, Real Estate Program, A. Alfred Taubman College of Architecture
& Urban Planning, University of Michigan, 2000 Bonisteel Boulevard, Ann Arbor, MI 48109-2069. Phone: (734)
615-8694.
Email address: [email protected] (David S. Bieri)
Preprint submitted to Encyclopedia of Quality of Life Research July 10, 2012
the 1980s (Gyourko, Kahn, and Tracy, 1999). The more widespread usage of the term housing
affordability among housing policy advocates, particularly in the United States and Europe, has
been widely criticized, both as a concept for analyzing housing problems and as a definition of
housing need (see Hulchanski, 1995, for a detailed overview of these criticism). The literature
on housing affordability tends to focus on either low-income families or median households.
When operationalizing housing affordability, policymakers have widely relied on the stan-
dard rule of thumb that households should not spend more than 30-35 percent of their income
on housing expenditures (Quigley and Raphael, 2004). In the United States, for example, pol-
icymakers have relied on the 30 percent threshold to identify the appropriate level of housing
subsidies for programs such as the Housing Choice Voucher (HCV) program. In this program,
the U.S. Department of Housing and Urban Development (HUD) defines metropolitan-level
“fair market rents” which are expressed in terms of the 40th percentile rent of standard-quality
rental housing units. This includes occupied units which are on 10 acres or less, which have
full plumbing and kitchen facilities, and which are more than two years old. HUD then pro-
vides assistance sufficient to close the gap between this fair market rents and 30 percent of a
low income household’s income.
In the United States, concerns over the availability of financing of affordable housing for
low- and moderate income families saw the establishment of Affordable Housing Goals in the
1980s requiring the Government Sponsored Enterprises to increase their purchases of mort-
gages originated by low- and moderate income households (Ambrose and Thibodeau, 2004).
Overall, the complex nature of the term housing affordability is reflected by the fact that
affordability is both a function of housing demand and supply factors. On the housing demand
side, affordability primarily depends on household income and the accessibility and cost hous-
ing credit. On the supply side, affordability depends on factors such as the cost of construction,
local land-use regulation (e.g. zoning restrictions, growth boundaries), and rent controls.

2. Measuring Housing Affordability

While the affordability of rental housing is usually directly captured in rent-to-income ra-
tios, economists argue that - in addition to real interest rate that measures the user cost of hous-
2
ing capital - an equivalent affordability measure of owner-occupied housing also depends on
taxes, depreciation and capital gains. Furthermore, since affordability measures depend both on
housing costs and incomes, developments in the distribution of income are likely to be of par-
ticular importance when explaining changes affordability experienced by lower-income house-
holds. While the housing-cost-to-income ratio approach has the longest history and widest
recognition, economists have recently re-emphasised an opportunity-cost based definition of
affordability in terms of “residual income”; according to this definition of affordability, a house-
hold is viewed as having an affordability problem if it cannot meet its nonhousing at some basic
level of adequacy after paying for shelter (Stone, 2008).

2.1. Alternative Measures

In addition to the housing cost-to-income ratio, structural changes in mortgage markets have
given rise to the notion of “purchase affordability” (the ability to borrow funds to purchase a
house) and “repayment affordability” (the burden imposed on a household from repaying hous-
ing debt) as important metrics for policy makers (Gan and Hill, 2009). Taking into account
the debt-servicing ratio leads to a different assessment of current house prices than do develop-
ments in the rent-to-income ratio itself. In most countries, the general increase in indebtedness,
due in part to deregulation in the mortgage markets, has been mostly offset by the secular de-
cline in borrowing rates and, with a few exceptions, households do not seem to devote a greater
share of their income to debt service than in the recent past.
In the United States, the National Association of Realtors provides a widely-used Housing
Affordability Index (HAI) that measures whether or not a typical family could qualify for a
mortgage loan on a typical home. Alternative versions of HAI that do not incorporate the cost
of housing finance simply express the average cost of a typical home as a multiple of the annual
average household income.
However, important aspects of housing quality depend on local nonmarket goods, such as
local public goods and amenities that are tied to the location of housing which in turn affects
the well-being of individuals and households. Consequently, an ideal measure of affordability
should also incorporate the opportunity facing households due to housing location, such as,

3
for example, differences in job accessibility, school quality, environmental quality and public
safety (see section 3 below for more discussion of this point; Fisher, Pollakowski, and Zabel
(2009) propose such an amenity-based housing affordability index.)

3. Housing Affordability and Quality of Life

Economists have long raised concerns about an affordability metric that combines both
income and housing costs, thus potentially conflating issues of income inequality with prob-
lems in the housing market and households’ consumption choices of nonmarket goods, such
as amenities or local public goods (see e.g. Glaeser and Gyourko, 2008). Indeed, the national
30 percent affordability threshold seems particularly problematic given that significant inter-
metropolitan differences in the ratio of income to housing cost are consistent with the basic
notion of a locational equilibrium, because differences in nonmarket goods are capitalised into
both housing prices and wages.

3.1. Wages, Rents and the Quality of Life

Urban economists generally think about quality of life in terms of the relative importance
of different factors to household well-being, usually expressed as utility. The key insight of this
literature rests on the observation that location-specific differences in wages and (land) rents
should compensate for the differences in nonmarket characteristics, such as natural or cultural
amenities that increase the attractiveness of a given locality. In other words, local differences in
the quality of life compensate households for below-average housing affordability, as approxi-
mated by the housing cost-to-income ratio.
A growing body of literature has tried to produce theoretically consistent quality-of-life
rankings for urban areas by deriving wage and rent differentials via hedonic methods, calcu-
lating the implicit prices of location-specific amenities which are then used as utility valuation
weights. Seminal work by Rosen (1979) and Roback (1982) demonstrates that households
are willing to pay more for housing and accept lower wages in metropolitan areas which pro-
vide a higher quality of life because of local amenity differences (see also Blomquist, Berger,
and Hoehn, 1988; Gyourko and Tracy, 1991; Albouy, 2008). For comprehensive surveys of
4
the growing quality of life literature, see, for example, Gyourko, Kahn, and Tracy (1999),
Blomquist and Dahlberg (2006), or Lambiri, Biagi, and Royuela (2007).

3.2. Housing Affordability with Local Wage and Price Variation

To the extent that this is the case, locations with the highest quality of life tend to be places
– ceteris paribus – with above average housing cost and below average wages. As a result, local
housing affordability conditions and quality of life tends to be negatively related as the most
desirable locations are likely to have the highest rent-to-income ratios. This has specific impli-
cations for the conduct of national housing policy. In the United States, for example, the stan-
dard subsidy is equivalent to the gap between fair market rents and 30 percent of income. Such
a housing affordability-related subsidy ignores differences in the typical housing bundle avail-
able within different types of metropolitan areas. For example, if the difference in fair market
rents between high-amenity and low-amenity metropolitan areas is fully capitalised into hous-
ing prices, then federal housing subsidies may be merely offsetting metropolitan differences in
amenity-related quality of life. As a result, households living in low-amenity metropolitan ar-
eas may be receiving lower quality housing bundles than households residing in high-amenity
areas, given an equivalent subsidy.
Yet, federal public housing and rental vouchers programs in the United States, for example,
are explicitly indexed to local prices by relying on local metropolitan-area median incomes
to determine eligibility and local fair market rents to determine the level of benefits. In their
current form, the affordability objectives of US federal housing policy are thus introducing both
locational inefficiencies and housing consumption inefficiencies (Bieri and Dawkins, 2012).

4. Housing Affordability during the Great Housing Boom and Bust

In the vast majority of OECD economies, there has been a secular upward trend in house
prices in real terms (the ratio of actual house prices to the consumer price index) since the
1970s, with a pronounced increase in growth rates since the mid-1990s that culminated in the
historic highs at the peak of the great housing boom of 2006.

5
 Figure 1: Real Prices of Residential Properties

Notes: The vertical line marks 15 September 2008, the date on which Lehman Brothers filed for Chapter 11
bankruptcy protection. Price indices are deflated by consumer prices; Source: Sources: Bank for International
Settlements (2011), 81st Annual Report, Basel: Switzerland, p. 20.

As average incomes grew more slowly during the 15-year run-up in house prices prior
to the financial crisis, overall housing affordability decreased in most of the major advanced
economies. However, the steep collapse in residential property prices has released some of the
pressure on housing affordability – at least at the national level – as personal incomes did not
experience a comparable contraction in most countries (see figure 1).
In the wake of the financial crisis, there seems to be a disconnect between affordability and
the anaemic recovery of the housing market, particularly in the United States and the United
Kingdom where affordable housing might not register as a political issue once the global eco-
nomic recovery is in full swing. Unlike other major political issues and despite its role in
sparking the financial crisis, housing is not seen as universally broken and housing policy ad-
vocates are concerned how to better position affordable housing on the national agenda (Lang,
Anacker, and Hornburg, 2008).

6
 References
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Working Paper No. 14472, National Bureau of Economic Research, Cambridge, MA.
Ambrose, B. W., and T. G. Thibodeau (2004): “Have the GSE Affordable Housing Goals Increased the Supply of
Mortgage Credit?,” Regional Science and Urban Economics, 34(3), 263–273.
Bieri, D. S., and C. J. Dawkins (2012): “Housing Affordability with Local Wage and Price Variation,” Unpub-
lished mimeograph, University of Michigan and University of Maryland.
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