New Paper Surveys Historical Performance and Methodology of Housing Affordability Indexes
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WASHINGTON, D.C. (August 2, 2016) - The Research Institute for Housing America (RIHA) today released a new report, 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. You can download a full copy of the paper here.
"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," Dr. Haurin said. "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," said Lynn Fisher, RIHA's Executive Director and MBA's Vice President of Research and Economics. "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: 1) measure out-of-pocket housing expenses compared to the amount of household income, 2) compare an arbitrarily chosen amount of income "needed" for non-housing expenses to a household's income after subtracting its housing expenses, 3) compare the cost of existing housing to the cost of producing new housing, and 4) measure the partial or the full economic cost of homeownership compared to household income.
The validity of an affordability index is difficult to test, 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. The predictive ability of three indexes is compared for 2003-2014, where the indexes are the National Association of Realtors' Housing Affordability Index, the National Association of Home Builders' Housing Opportunity Index, and the new Dynamic Housing Affordability Index (DHAI).
The study finds that the DHAI is a better predictor of housing starts and sales of new and existing homes. However, none of these indexes correctly predictedthe steady decline in the homeownership rate after 2004, even when households' diminished access to the credit market is accounted for.
RIHA's chief purpose is to encourage and assist--through grants to distinguished scholars and subject matter experts, educational institutions, research facilities and government organizations--establishment of a broader based knowledge of mortgage banking and real estate finance. You can find additional papers on RIHA's website: www.housingamerica.org.