Measuring Housing Affordability:
The inability to afford a decent shelter has a detrimental effect on people’s lives, their well-being and productivity, and the broader economy. Given the pervasiveness of the problem on a global scale, housing affordability is increasingly taking center stage in public discourse. Yet, there is little agreement on the definition of housing affordability and how to measure it. This paper draws on academic literature and lessons from government housing programs to evaluate how accurately conventional measures differentiate affordability levels by income segment, household composition, and tenure.
With the objective of more accurately measuring the affordability of housing at the household and aggregate levels, the paper recommends testing (i) a progressive housing Expenditure-to-Income ratio, calibrated by income segment, and (ii) a modified Residual Income Method that uses household expenditure instead of income as well as a simplified budget standard for non-housing expenses. Application of the latter methodology in urban Pakistan highlights a significant underestimation of housing unaffordability using conventional approaches, especially for the lowest income groups. Moreover, the case study indicates that conventional approaches to the measurement of affordability may not adequately reveal the differences in affordability across income segments and household compositions.
The inability to afford a decent shelter has a detrimental effect on people’s lives, their well-being and productivity, and the broader economy. In the 1970s and 1980s, the unaffordability of housing was considered a problem of lower-income groups; today, it encompasses middle-income households in many of the world’s cities. Attempts in both developed and developing economies to stem the growing differential between income levels and housing prices have had limited impact. According to the McKinsey Global Institute, the affordable housing gap is $650 billion a year and will impact 1.6 billion people by 2025 (Garemo et al. 2014).
Given the pervasiveness of the problem on a global scale, housing affordability is increasingly a focus of public discourse – for policymakers, politicians, academics, industry professionals, and communities alike. Yet, there is little agreement on what affordability means, how to measure it, and whether the conventional measures of housing affordability adequately reflect reality. An ill-defined and poorly measured affordability problem can lead to inappropriate policy responses that may have little or no effect on ameliorating housing problems or may even exacerbate them.
The topic of housing affordability is of particular importance to the World Bank and other development institutions. Sustainable Development Goal 11 requires affordable housing for all by 2030 but does not provide a definition of affordability. There is also a lack of clarity or agreement on what an ‘affordable house’ is and how ‘housing affordability’ should be defined for those in the bottom 40 percent of the income distribution.
The conventional practice has been to use a standardized housing affordability measure across all income segments (e.g., the 30 percent housing expenditure-to-income ratio). While this may be a rough measure to calculate affordability, it does not always accurately reflect a household’s budget reality, particularly for the poor. The inability of such conventional measures to differentiate affordability levels by income segment household composition or tenure – which are all critical factors that determine what a household can actually afford to allocate for housing–may result in overestimating affordability challenges for some and underestimating it for others.
Accurate measurement of housing affordability at the aggregate level is necessary to inform policy design. For example, what portion of the population is housing cost overburdened? Which sub-groups? Which tenure type? Which cities or sub-markets are facing an affordability crisis? What is the real housing deficit by income segment or sub-group? Similarly, an accurate measurement of housing affordability at the household level is also necessary to inform program design: How much can a specific household pay for housing without compromising other essential needs? What housing options are available within that housing budget, and where are the gaps How much and what type of subsidy does the household need to comfortably make housing payments?