What are some of the key characteristics of a healthy housing system? And how can the success of these features be measured?
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A well functioning housing system must have three attributes: product diversity, financial and product liquidity, and household affordability. All three of these issues are connected and system health requires a balance between the three factors.
Product diversity refers to such things as lot and building size, design, location, tenure, and the embedded amenities of location. Housing diversification is more important in societies driven increasingly by consumer choice even in periods (such as today) when choices are constrained by income, housing values, and credit availability. The more dynamic a society is, due to things such as rapid changes in household size or regional variation, the more important it is to be able to diversify and segment product. Product diversification is one marker of financial resilience in housing markets; particularly during a financial crisis.
Liquidity for a housing product means that consumers have the capacity to buy or rent as well as sell and move. Liquidity for capital means efficiency in allocation and circulation, such that long term interest rate risk is manageable and local capital circulation allows for increased access to new borrowers.
As the recent housing and financial crisis demonstrated, liquidity can solve one set of problems (interest rate risk and capital circulation) while it creates a new set of problems (deterioration in underwriting standards and obscuring balance sheet risk by uninformed investors).
Household affordability refers to the amount of income required to pay for housing and housing related expenses. Affordability ratios derive from historical bank underwriting standards and also reflect cultural contexts regarding the expectations of a full range of household costs for housing and non-housing consumer goods.
In a more direct sense, affordability is connected to building costs which are tied to other variables such as labor, materials, zoning, and regulations. And in many instances government subsidy, subsidizes costs not related to a lack of income but to components of building costs that could otherwise be reduced through innovation, competition, and smarter regulations.
All three attributes – products, liquidity, and affordability –are measured by a variety of indicators available to us: demand and supply calculations for various housing types, demographic projections, bank balance sheets, mortgage bond yields, and the balance sheets of households with regard to rental and ownership costs, as well as total leverage.
Calculating the health of a housing market requires models that include the interaction of all three attributes, otherwise we can arrive at a skewed vision of health. We had the most liquid housing market imaginable in 2006 but that liquidity obscured short term affordability challenges (measured by household leverage), financial institution problems (measured by leverage and capital adequacy), and product diversification issues (measured by an unsustainable homeownership boom, rather than a more balanced renter and ownership selection).
Jeremy Nowak is President and CEO of the William Penn Foundation.
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