A Dynamic Housing Affordability Index

Abstract

This paper outlines an approach to constructing a Dynamic Housing Affordability Index (DHAI) that reflects the true cost of owner-occupied housing and performs well in tracking changes in the demand for homeownership and other aspects of the housing market. Our index is grounded in user cost theory and it is influenced by variations in the price of housing, mortgage interest and property tax rates, property insurance, transactions costs, and depreciation and maintenance. It takes into account the benefits from the U.S. income tax deductions for mortgage interest and property taxes and it considers the role of expected house price inflation in reducing the cost of housing. We show that the DHAI predicts national and regional consumer sentiment with respect to the demand for owner-occupied housing, regional and MSA homeownership rates, and housing market characteristics including housing starts, and sales of new and existing housing. There is evidence that the DHAI performs better than other popular measures of affordability.

Keywords: housing affordability, housing market characteristics

JEL Classification: R31, C43