Market Economics - Memo

Latest news & views from market economics / May 2016

M.E consultant Nicky Smith recently graduated with her PhD. We are all very proud of her achievement.

New Team Member 
We recently welcomed Emily Harvey to the M.E Environment team. Emily has a PhD in Mathematical Modelling and is contributing her skills to our economic modelling work.

NZPI Conference 16 
M.E was a sponsor at the recent conference in Dunedin.  We commend the organising committee for an informative and well run event.


Auckland Housing Affordability #1

Auckland’s property market and housing affordability are high profile matters. There is considerable interest, and debate, as to the underlying causes. And there is much concern about the long term effects on the community. M.E has been closely involved in developing the evidence base on Auckland’s housing and growth capacity. Drawing from that work, this M.EMO is the first in a series on housing and considers how we assess affordability and the usefulness of some broad indicators

How we assess housing affordability

Thankfully, affordability is a simple concept – how much we have to spend (usually in dollar terms) compared with what we wish to acquire – and housing is no different. It’s just that housing is the largest item of expenditure for most households, and it usually requires major effort to assemble a deposit and on-going effort – typically over at least two decades – to service and pay off a loan. 

Median Dwelling Price to Median Income Ratio

A commonly cited indicator of housing affordability is the ratio of median dwelling price to median household income. This is a very simple indicator, which draws on easily available information. In Auckland recently, this ratio has exceeded 9 – that is, the median house price is more than 9 times the median income. The relationship between dwelling prices and incomes is important, because households need to be able to service and re-pay (housing) loans, within an achievable time frame. In broad terms, a household can expect to service and repay a debt which is 5 times the household income within around 20 years - a debt which is 6 times the household income takes about 25 years.

However, when a household’s debt gets much beyond 6 or 6.5 times the household income, it is more difficult to pay back the loan within the time frame – which means households need to commit a greater share of income to loan repayments, and/or a longer loan payback period.

Understanding these broad parameters of household income and debt levels underpins the thinking behind the dwelling price to median income indicator.

Which raises the obvious question of why - if the price to income ratio is around 9, and Auckland’s housing is stated to be “unaffordable” - the Auckland market continues to rise, and there appears to be no shortage of buyers willing – or at least able – to pay the prices sought? Certainly, investors continue to account for a significant share of purchases, around 37% of the total, and affordability for investors is heavily influenced by the rental income they can get, rather than just their other income as a household. However, the largest purchasing group - around 41% in the 2014 and 2015 years according to Corelogic’s data – comprises owner-occupier households who purchase one dwelling and sell their previous dwelling.

How is it that these ordinary households can purchase dwellings at well above their affordability levels?

The answer is fairly clear when we delve a bit more into the process itself, and the figures behind it. There are many Auckland households who can move upwards in the housing market without venturing into the “unaffordable” territory. This is because they have already been dwelling owners for a number of years, and they have been able to build up equity in their existing dwelling. From that base, they can afford a higher value dwelling.

This is not, of course, rocket science, but it is useful to understand how this works for them. One part of the M.E Housing Affordability Model examines this group, those existing owners looking to move upward in the market. The Model draws together the relevant information from Auckland’s housing market over the last 25 years, including loan servicing and the effects of past inflation on dwelling prices. This is applied to identify what priced dwelling a household on the median income (about $82,000 for Auckland in 2015) can now afford, taking account of the value of the dwelling being sold, and how long the household has owned it. Not surprisingly, the longer their ownership period, the greater the increase in dwelling price which they are able to afford. Many can afford dwellings which cost far more than 4 or 5 times their income level.

This is because the key question on affordability is not the price of the next dwelling, but rather the level of debt needed to purchase it. The affordability of this debt is related to income – a debt to income ratio of about 4.5 is sustainable, on the standard assumption that debt servicing does not exceed 30% of gross household income. And it is encouraging to see some economic commentators now placing greater emphasis on debt levels in the affordability debate.

What this means is that (as an example) a household selling their current dwelling for $400,000 – having owned that dwelling for 10 years – can afford to buy the next dwelling for $615,000 and still have a level of debt quite affordable – that is, a debt to income ratio of around 4.5.

Table 1 shows the “next dwelling” price levels which are affordable to households on the median income which sell off their existing dwelling. The table shows a selection of selling price points, a selection of time periods of ownership, and the affordable price of the “next dwelling”. For example, a household which sells their current dwelling for $600,000 after having owned it for 10 years could afford a next dwelling of $740,000. If they had owned the current dwelling for 15 years, they could afford a next dwelling of $860,000.

Table 1: Housing Affordability for Existing Dwelling Owners

The lower part of Table 1 shows the oft-cited ratio of dwelling price to median income. Every one of these ratios – which range from 6.6 to 12.2 - would indicate purchases which are deemed unaffordable. However, all of the purchases are affordable to households which currently own a dwelling because their debt to income ratio in every case is around 4.5.

The implication is that the median dwelling price to median income ratio applied to the entire market is not a particularly useful indicator of affordability for owner-occupier households which make up the largest share of the housing market.

A better indicator of housing affordability is the debt to income ratio to which purchasers commit when buying a dwelling.

First Home Buyers

Nevertheless, the house price to median income ratio is a rather more useful indicator when the dwelling price paid is predominantly borrowed money, and the dwelling price is a good indicator of the level of debt for the purchasing household. This is especially the case for first home buyers (FHBs), who may borrow up to 80% of the purchase price with the LVR rules requiring a 20% deposit, though some may borrow 85%. The important indicator is the debt to income ratio, so the dwelling price information needs to be considered carefully. For example, a dwelling price of $600,000 shows a price to median income ratio of 7.3. However, with a 20% deposit, the debt to median income ratio is 5.8.

Of course, use of a more accurate indicator of affordability does not mean that Auckland’s low housing affordability is not a major issue – in the example, the debt to income ratio of 5.8 still puts it outside the affordable range. And there is a lot of anecdotal evidence which suggests that some or much of first home buyers’ saved deposits may be debt rather than savings, albeit less formalised debt – for example, funds borrowed from family, or personal loans from other sources of finance. In those cases, the real debt to income ratio would be higher than the apparent ratio.

Affordability Indicators

The limited relevance of the broad median dwelling price to median income ratio to those who already own a dwelling, as well as to investors, but the greater relevance to first home buyers, points to the need for affordability indicators which are specific to FHBs. These FHBs are the key group, because the greatest hurdle is getting into dwelling ownership, and high dwelling prices mean that fewer households are able to make that step. This is evident in both the decline in dwelling ownership rates, and the later time (higher age groups) at which first home ownership is being achieved, as shown in successive Censuses. This suggests some focus on the 25-34 age groups, as the key life stage for entering into dwelling ownership.

Since housing affordability for FHBs is a critical issue, then indicators are needed to show and monitor the situation for FHBs. Their median income in relation to dwelling price bands is relevant, but other indicators are important to get a clearer picture.

A debt to income ratio is one indicator. Another is the volume of supply which is potentially available. Another is the share of household income required to service debt - it is clear that as many households make the stretch to become dwelling owners, they put more than 30% of their gross income to housing, and exceed the “standard” threshold. A fourth is the length of time needed to save a deposit, which is influenced by both income levels and rental rates.

Indicators for FHBs also need to be related to their market position. FHBs generally purchase dwellings of lower than average value. Corelogic data for 2014 and 2015 shows that the average purchase price paid by first home buyers was around 9% below the all-purchaser average. This suggests that the median price across all dwellings is less relevant to FHBs than an indicator such as the 30th percentile ($590,000) or even 40th percentile ($650,000) dwelling price.

Similarly, it is important to understand the income levels of those in the critical age groups. While the median income for all Auckland households reached $82,100 in 2015, the median for households in the 25-34 age groups is somewhat higher, at around $93,000 according to Census and HES statistics. The median income for households in this age group who did not own a dwelling was $74,000.

It is straightforward to show dwelling affordability for households in each income band, based on 20% deposit and debt to income ratio of 4.5. Figure 1 illustrates the situation for Auckland households in the 25-34 age band, using 2015 dwelling prices and 2015 income levels.

Figure 1: Auckland Households 25-34yrs – Dwelling Affordability

This shows that a dwelling at the median price is affordable for only those households at or above the 70th income percentile – that is, only those in the highest 30% of incomes. Simply, the median priced dwelling is not affordable for 70% of households in this key age band.

A dwelling at the 40th price percentile is affordable for those at or above the 60th income percentile – that is, those in the highest 40% of incomes. For the other 60% of households in this age band, a dwelling at this price is not affordable. 

A dwelling at the 30th price percentile is affordable for those at or above the 55th income percentile – that is, those in the highest 45% of incomes. For the other 55% of households in this age band, a dwelling at this price is not affordable.

This ability to identify the situation in a bit more detail for FHBs or other segments within the community is very important for understanding both the nature and the extent of the housing affordability issue – and for developing appropriate responses to help solve it. There is plenty of sound information to support policy development, and it is important to utilise that rather than rely on very simple indicators which do not get to the heart of the issues.

This does not diminish the critical issue of housing affordability in any way. What the discussion does highlight is that affordability needs to be well informed by accurate indicators, which are relevant and sensitive to different segments of the market, and particularly first home buyers who are most affected by reduced affordability.

This is especially so in the light of recent suggestions – including by the Productivity Commission and latterly the Government – that the ratio of median dwelling price to median income could be used as a trigger for local authorities to increase the provision for dwelling capacity. Even if it were an accurate indicator, the underlying economic rationale for such an approach to planning is dubious. For example, while raw land supply has some influence on dwelling prices, there are many other factors with equal or more significant effects – research by central Government identified that in the Auckland market a -19% reduction in land price could be expected to have a -0.5% effect on housing prices. Other factors – such as the level of in-migration and the ease with which housing finance is available – also influence housing prices directly and strongly.

Any single indicator by itself only provides part of the picture. Experience tells us that more thorough assessment across the range of relevant factors is necessary to have a sound evidence base for decision-making.

To read the next article in this series, click here.

For further information about this article, please contact Douglas Fairgray, 09 915 5514 or


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