ST’s attempt to measure affordability

Source : Straits Times – 19 Sep 2009

THERE are many ways of calculating affordability, and every organisation that is interested in doing so – property firms, governments, banks – probably has its own individual index.

But one of the most internationally recognised measures is the price-income ratio, which is recommended by the United Nations and the World Bank. The ratio divides the price of a private home by a potential buyer’s annual income.

It is widely used because it is simple and uses readily available data on home prices and incomes. However, it is not as straightforward as it looks.

While only two factors are involved, they can each be calculated in a variety of ways.

For instance, should median income and median prices be used? The median is the figure at which half the number of values are higher and the other half lower. Or would the average figure for both better reflect the range of home prices? For prices, is it better to take the total price of a home – which, after all, is the amount buyers will use to determine affordability – or to use the per sq ft price, which also takes into account the fact that homes are getting smaller?

There is also the question of which measure of income to use: individual income or household income? And should it be the income of all households in Singapore, or only the income of employed households in which at least one person is working?

Finally, all comparisons must be done in reference to an earlier period. But which previous year should be used as a reference point? Using a boom year or a slump year could skew comparison equally and in different directions.

To compute the price-income ratio, The Straits Times took the prices of all private home sales since 1995, obtained online from the Urban Redevelopment Authority’s Real Estate Information System. This is preferred over using a basket of properties, as some analysts do. Income figures were obtained from the Department of Statistics. Monthly incomes of all resident households were multiplied by 12 to get annual incomes.

We took the median measures of price and income, to avoid skewing the result. On top of that, we also did the same calculations using average prices and incomes and found that the conclusions were largely the same.

Property consultants also agreed household income would be a better measure, since most households pool their money to buy a home.

We took the median income of all households in Singapore, because it is not only working households that need a roof over their heads.

To overcome the issue of which year to choose as the best reference point, we drew up a time series showing the price-income ratio over the years, dating back to 1995. Beyond it, home price data is not publicly available.

This period covers the epic boom of 1996 and 1997, the plunge in 1998, a mini-boom in 1999 and 2000, the subsequent slump that started in 2001 and led to the ‘dry years’ of 2002 to 2005, and the most recent boom and bust of 2006 to 2008.

From the chart, it is clear housing prices, as measured in terms of annual incomes, declined last year to match the comparatively affordable levels of the early 2000s. Even during the peak in 2007, affordability was higher than in previous peaks of 1996 and 2000.