The residual income method: a new lens on housing affordability and market behaviour

Final report

• Terry Burke, Michael Stone, Liss Ralston
• Australian Housing and Urban Research Institute (AHURI)

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12 October 2011 This study was designed to explore the viability of an alternative method of measuring housing affordability stress (using the residual income method) to that of the ubiquitous 30 per cent benchmark method. The project will help devise rent-setting formulas for social housing that better correspond to need; improve the efficiency and equity of housing subsidy allocation; and better assess risks in home purchase.

Description

The residual income method calculates how much is left over for housing rents or mortgage after relevant expenditure items for different household types have been taken into account. If there is insufficient income left for rents and mortgages after meeting this budget standard, a household is thought to have an affordability problem.

For a broad measure of affordability across all households, the residual income method provides results not too dissimilar to the benchmark method for estimating housing affordability stress (i.e. the 30/40 rule).  However for the lowest 40 per cent of income earners and using the Low Cost Budget Standard, there is a much higher incidence of households with affordability problems (33.6%) compared to the 30/40 method (23.9%).

Furthermore, the results are affected by the type of household and their different expenditures.  Using the residual income method, there are severe affordability problems among aged renters (84.3% of singles and 62.2% of couples), and families with young children under five (68%).

Modeling using the residual income measure shows that above a certain income point there is much greater capacity to purchase or rent than the much used 30 per cent rule would tell us. It also suggests that under the current rent structure in social housing those on very low incomes may be paying an excessive amount of income on rents while those on higher incomes generally have a greater margin to afford housing costs.  By contrast, modeling of income eligibility mechanisms of the National Rental Affordability Scheme (with its discounted rent) reveals that relatively few households experienced affordability problems.

The residual income method is useful for more informed decision-making around affordability issues.  Policy makers should be concerned that for certain groups existing measures may be under-measuring the problem of affordability (especially old age and families, those on low incomes in public housing), but be reassured that for others (e.g. those on higher incomes purchasing a house) the problems of affordability may be overstated.

Image: tarale / flickr