What is the Affordability Index?


Sharon Taylor

Affordability formula

 

When trying to read an individual property market the Affordability Index (AI) is one of the most important statistics.

The AI is a measure of affordability. In essence, it is a measure of how much of the average wage is consumed by the average mortgage repayment in that specific market.

There are a number of different ways this Affordability Index can be calculated.  At Performance Property Advisory, the method used is as follows:

  1. Using the current median price data from BIS Shrapnel, and assuming a 20% deposit, we can calculate what the average mortgage size is for a new entrant into that market.
  2. We then use the standard variable interest rate data from Loan Sense to calculate an annual interest only repayment.
  3. Lastly, we divide that interest repayment by the average annual gross income for that area, using State wage data from the ABS and Regional wage data from the Census.

 

Understanding the method of calculation is important, as there can be subtle differences in how various organisations calculate the figure. Differences in the calculations can depend on the use of:

  • Principle and interest loans or interest only loans
  • The standard variable rate, RBA cash rate or some other bank rate
  • The amount of deposit
  • Census data for wages or ABS data for the State wages
  • Median prices from ABS, RP data, APM, Bis Shrapnel, or others

 

With this in mind, it is impossible to compare a NAB affordability index from 1980 with our PPA Affordability Index from 2017 and draw any conclusions. Our Affordability Index goes back to 1985 and we have graphed it against the corresponding move in median prices.

This statistic is important because every market has different tolerances whereby, when a particular Affordability Index is hit, prices will most likely stagnate or decline. At the other end of the scale, when a different point is hit, prices will rise.

It is important to note, however, that statistics cannot be relied upon in isolation. Two examples demonstrate this point:

Sydney

At the time of writing this article we have the PPA affordability index in Sydney at 56%. Historically, Sydney finds it extremely difficult to rise in value past 55%, so the current probability of price rises in Sydney are very low, especially in the face of rising interest rates. 

Cairns

Conversely, the other end of the scale is Cairns where the affordability index is 22%. Historically at this point the market has always grown. So whilst the affordability index in Cairns is low and median prices should logically rise, the market is being held back by high unemployment and a general lack of confidence.

 

In order to assess where a particular market is in the cycle we review on average 25-30 macro and micro statistics. 

 

Sharon Taylor
Senior Research Analyst - Performance Property Advisory

Sharon heads up the research division at Performance Property Advisory. As part of our ongoing service to clients, Sharon provides contemporary advice in a range of areas, including growth suburbs and regions, demographics and employment rates, proposed infrastructure developments and other aspects that will contribute to a positive return on their investment.