Why do cities become unaffordable?
In many of the world’s urban centres, homes are becoming prohibitively expensive for people with moderate incomes. As a city’s real-estate prices rise, some inhabitants may feel compelled to leave. Of course, if that inhabitant already owned a house there that they can sell, they may regard the price increase as a windfall that they can claim by departing. If not, however, they may be forced out with no compensation.
As such people depart, an expensive city gradually becomes an enclave of high-income households, and begins to take on their values. With people of various income levels increasingly divided by geography, income inequality can worsen and the risk of social polarisation – and even serious conflict – can grow.
As the 2017 Demographia International Housing Affordability Survey shows, there are already massive disparities across major global cities (measured by the ratio of median home prices to median household income). A high ratio correlates with high pressure for people to leave.
Least affordable cities
This year’s survey, which covered 92 cities in nine countries, showed that, as of late 2016, Hong Kong had the least affordable housing, with a price-to-income ratio of 18.1. That means that paying off a 30-year mortgage on a median-price home would cost a median-income buyer more than half of their income – and that is without interest. Mortgage rates are low in Hong Kong, but not zero, suggesting it is just about impossible for a median-income household to purchase a home there without access to additional funds from, for example, a parent, or, if the buyer is an immigrant, from abroad.
After Hong Kong, the list continues with Sydney (12.2), Vancouver (11.8), Auckland (10), San Jose/Silicon Valley (9.6), Melbourne (9.5), and Los Angeles (9.3). Next come London and Toronto – at 8.5 and 7.7, respectively – where housing is extremely expensive, but incomes are also high.
Meanwhile, some attractive world cities are quite affordable, relative to incomes. In New York City, the median home price stands at 5.7 times median household income. In Montreal and Singapore, that ratio is 4.8; in Tokyo and Yokohama, it is 4.7; and in Chicago, it is 3.8.
What the above shows is that home affordability around the world is highly variable. The question, then, is why residents of some cities face extremely – even prohibitively – high prices.
The construction cost barrier
In many cases, the answer appears to be related to barriers to housing construction. Using satellite data for major US cities, the economist Albert Saiz of MIT confirmed that tighter physical constraints – such as surrounding bodies of water or land gradients that make properties unsuitable for extensive building – tend to correlate with higher home prices.
But the barriers may also be political. A huge dose of moderate-income housing construction would have a major impact on affordability. But the existing owners of high-priced homes have little incentive to support such construction, which would diminish the value of their own investment. Indeed, their resistance may be as intractable as a lake’s edge. As a result, local councils may be unwilling to grant permits to expand supply. Recent opposition to the Auckland Unitary Plan by groups within wealthy suburbs such as Remuera and St Heliers are good examples of this sort of opposition.
Insufficient options for construction can be the driving force behind a rising price-to-income ratio, with home prices increasing over the long-term even if the city has acquired no new industries or people. Once the city has run out of available building sites, its continued growth must be accommodated by the departure of lower-income people.
A good example of this is comparing the cost of building a house in Auckland vs Christchurch. Auckland houses are often built on hillsides or in new subdivisions which have had to be extensively re-contoured and the land drained. Additionally, the cost of sewerage, power and water reticulation, and roading construction in Auckland are all higher than in Christchurch where houses are predominantly built on the flat, and ample shingle is available for roading and concrete.
Adapted from an article written by Robert J. Shiller, a 2013 Nobel laureate in economics, and professor of economics at Yale University.