How to calculate house affordability in cities

[Thorin]

I came across this article (http://www.vancouversun.com/West+Coast+cities+global+most+unaffordable+list/1226864/story.html) which discusses a study where the researchers were pinning down how affordable houses were in different cities around the world.

At first it was the headline that caught me ("West Coast cities on global most unaffordable list" - well, duh, everyone knows Vancouver is expensive to live in).  But as I read the article and came to understand how they figured this out, I thought, "Wow, that's brilliantly simple".

Basically, the formula is median house price divided by median annual income.  So lets say you live somewhere where the median house price is $300,000 and the median annual income is $50,000 - the "affordability" index would then be 6.0.

To compare, Vancouver has an affordability index of 8.4, the Canadian average affordability index is 3.5, and the lowest in Canada is Cape Breton at 2.1.  So much for the myth that Vancouver's higher house prices are offset by higher incomes.

[Thorin]

I found the actual study, and in it they discuss the housing bubble and why it occurred:

Various theories have been used to describe why the housing bubble occurred. More often than not, the theories describe influences that occurred in all markets. In the metropolitan markets of the United States and Canada, general theories are simply inappropriate. This is because the house price escalation varied far more than can be explained by any factor operating at the national level. This is a serious error in light of the radically different house price increase experience between metropolitan markets in the United States and Canada. In some markets, the Median Multiple doubled or even tripled. In other markets, the Median Multiple remained below the historic maximum norm. Any plausible theory must describe why house prices virtually ?exploded? in some markets, while remaining at or near historic norms in other markets.

The most frequently cited implausible theories include the following.

Demand: It has been suggested that the looser credit policies increased demand, which led to higher prices. Moreover, demand, however, cannot explain why some markets had such large price increases and others had such small increases. Overall, US responsive market prices relative to incomes increased only 0.6 times household incomes during the bubble. By contrast, prices increased more than four times as much (2.6 times incomes) in the United States in the prescriptive markets. Demand rose all over, because mortgage credit was equally easier to obtain in all markets. Yet, demand was at its greatest in some of the markets with the least price inflation (such as Atlanta, Dallas-Fort Worth and Houston).

Attractiveness: Some have suggested that the Median Multiple rose much more quickly in ?desirable? markets such as Los Angeles, San Francisco and New York. Yet, prices in these markets have never diverged so much from historic norms or the prices in rest of the nation. There is nothing to suggest that the more expensive markets had become more attractive over the past decade of cost escalation. Indeed, domestic migration data shows a strong outflow of people from the so-called more attractive, but less affordable areas to more affordable areas.

Construction Costs: The differences in housing costs and trends cannot be explained by construction costs. For example, in 2007, the cost to build an averaged sized house in San Diego was approximately $40,000 more than in Dallas-Fort Worth and $15,000 more than in Indianapolis. Yet the San Diego median house price was $440,000 higher than in Dallas-Fort Worth and $465,000 higher than in Indianapolis. Over the previous ten years, construction costs in San Diego rose 1 percent relative to costs in Dallas-Fort Worth declined relative to costs in Indianapolis. The comparisons are more stark in Canada. In 2007 the cost to build an averaged sized house in Vancouver was approximately $20,000 less than in Quebec (metropolitan area) and only $6,000 more than in Winnipeg. Yet the Vancouver median house price was more than $350,000 higher than in both Quebec and Winnipeg. Over the
previous ten years, construction costs in the Vancouver area declined relative to costs in
Quebec and Winnipeg.

The Difference: There are substantial differences between metropolitan markets in one factor of market influence: land use regulation. Generally, land use regulation falls into the following two categories:

Responsive land use regulation: Liberal or traditional regulation is referred to as responsive land use regulation because it responds principally to the market as revealed by people?s preferences. Under responsive land use regulation, there is a substantial interplay between buyers and sellers of land, resulting in generally lower land (and house) costs.

Prescriptive land use regulation: The newer regulatory systems are referred to as prescriptive land use regulation because they are based on ?visions? or plans, which prescribe where development is to occur. Under prescriptive land use regulation, the interplay between buyers and sellers of land is substantially interfered with, resulting in generally higher land (and house) costs.

Economics, Land Use Regulation and Housing Affordability

Economics teaches that scarcity raises prices. In a number of metropolitan markets, land for development has become scarce due to prescriptive land use policies, such as urban growth boundaries, huge areas recently declared off-limits to development, building moratoria, confiscatory and unprecedented impact fees, minimum lot sizes and expensive amenities.

source: http://www.demographia.com/dhi-ix2005q3.pdf

Essentially, they're making the case that it is the restrictive land-use bylaws that cause house prices to surge wildly - if the land-use bylaws allow builders to build a wider variety of structures on a piece of land, the housing market responds quicker to an increased demand, and thus housing prices don't increase as fast as there is more supply.

Interesting theory, as North American municipalities are gravitating more and more towards restrictive land-use bylaws that specify not just whether a section of land can have multiple-unit, double-unit, or single-unit buildins (aka apartment-style, duplex-style, detached house), but the bylaws are now starting to state minimum house widths and heights for specific lot sizes.

[Bixby]

Cool beans, thanks for sharing!