The Research Institute for Housing America (RIHA) released a new report titled “The Affordability of Owner-Occupied Housing in the United States: Economic Perspectives,” which looks at four major forms of affordability indexes, compares their methodology, and tests their validity in predicting current and historical features of the housing market.
RIHA is a 501(c) (3) trust fund founded by the Mortgage Bankers Association (MBA) and devoted to independent research of housing and mortgage markets. The study was authored by Donald R. Haurin, Professor of Economics, Emeritus, Ohio State University.
“There are many conceptualizations of how to measure housing affordability and there are many affordability indexes. All measures are based on judgments of which components of housing costs should be included and judgments about when these costs should be considered excessive,” Haurin said in the report. “This study reviews existing theory and empirical work about the affordability of owner-occupied housing. It concludes that only a few affordability indexes are well grounded in economic theory, although all contain ad hoc assumptions.”
“Many analysts comment on the extent to which housing is affordable. However, the precise meaning of ‘affordability’ is hard to pin down. And existing affordability indexes do not seem to predict housing variables of interest,” RIHA Executive Director and MBA Vice President of Research and Economics Lynn Fisher said in the report. “Taking a critical look at these indexes, Dr. Haurin finds that consumer expectations about future house prices are an important variable to consider. If home prices are expected to increase, it effectively lowers the cost for a homebuyer purchasing today, because they will benefit from that capital gain. On the other hand if house prices are expected to fall, as they were during the recession, affordability is reduced even though current prices may appear low, because homebuyers will suffer a capital loss over time. Incorporating house price expectations improves the ability of a new index to predict homebuyer behavior.”
The study describes four major forms of affordability indexes. They include ones that measure out-of-pocket housing expenses compared to the amount of household income, compare an arbitrarily chosen amount of income “needed” for non-housing expenses to a household’s income after subtracting its housing expenses, compare the cost of existing housing to the cost of producing new housing, and measure the partial or the full economic cost of homeownership compared to household income.
The validity of an affordability index is difficult to test, the report said, but index performance should be measured against specific criteria. This study establishes criteria that an affordability index should be able to predict current features of the housing market including sales of new and existing houses, housing starts, and the homeownership rate.