This study was designed to explore the viability of an alternative method of measuring affordability (the residual income method) to that of the ubiquitous 30 per cent benchmark method and to use this alternative method for enriching understanding around a range of affordability and housing market issues. The work has been exploratory but it does reveal both the potential and the limitations of the method. Put simply, 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 left for rents and mortgages after meeting this budget standard, a household has an affordability problem. The basis for formulating such a measure for Australia was enabled by the development of indicative budget standards by the Social Policy Research Centre (SPRC) at the University of New South Wales (Saunders et al. 1998). They established a low cost budget standard (LCBS) and a modest cost budget standard (MCBS); the former might be seen as a minimum level of consumption in contemporary Australia, while the latter allows for a comfortable but far from luxurious lifestyle. Both have been used in this study, but with most emphasis on the LCBS, and have been indexed to relevant years by a composite index of the CPI minus housing component and of disposable Income. This Final Report is not an exhaustive treatment of the residual income method but is designed to illustrate its potential, relative to benchmark methods, for understanding a number of housing affordability related issues. And, while the subject matter could potentially be quite technical and detailed, the report aims to minimise the detail and concentrate on understanding and exemplification. The report has a number of objectives: 1. Use the residual income method to calculate the distribution of housing affordability in Australia in aggregate and for individual household types by tenure, income, state and other relevant variables in order to get some assessment of the scale and distribution of residual income affordability. This includes comparison with the ratio method, either the aggregate 30 per cent measure or the more targeted 30/40 ratio, that is, 30 per cent for the lowest 40 per cent of income earners. 2. Compare these aggregate Australian findings with those for the USA, as representing a form of benchmark to assess how badly or well Australia performs in terms of affordability. 3. Model the affordability capacity of case study households (single person, couple with two children) across a broad income range to provide a better understanding of how affordability constraints, as indicated by the residual income method, are potentially shaping the operation of housing markets. 4. Illustrate using the Melbourne and Adelaide home purchase markets what the residual income method suggests about the performance of these housing markets in terms of affordability. 5. Illustrate using the Melbourne rental market what the residual income method suggests about the performance of this housing market and associated submarkets in terms of affordability. 6. Test the appropriateness of the residual income method for social and affordable housing rent-setting policy and eligibility practices.
Stone, Michael E.; Burke, Terry; and Ralston, Liss, "The Residual Income Method: A New Lens on Housing Affordability and Market Behaviour" (2011). Community Studies Faculty Publication Series. 1.