2.6 The house price-to-income ratio
The house price-to-income ratio takes the basic form of:
- Average house price ÷ Average income of buyers
This ratio is the starting point for the data shown in Figure 6. However, some adjustments have been made so that, for each country, the ratio in any period can be compared with its long-run average value. First, the average of the ratio has been calculated over a long period (several decades). The ratio for each period has then been divided by this long-run average. Finally, the answers have then been turned into index values, and it is those index values that are plotted in the chart in Figure 6. You looked at index values earlier – recall that they show the value of something (in this case how the house-price-to-income ratio compares with its long-run average) relative to a base value which is set at 100.
These adjustments may seem complicated but they mean we can describe house prices relative to income as being high or low relative to the long-run value of the ratio. And the adjustments strip out the differences caused by different currencies and different average house price levels between countries. If the figure for a particular period:
- equals 100, this means the house price-to-income ratio is the same as the long-run average
- is lower than 100, the ratio is below the long-run average and might suggest home buying is relatively cheap
- is higher than 100, the ratio is above the long-run average and this might suggest that house prices are high – or even too high – compared to average incomes.
Activity 4 Housing affordability
Using Figure 6, comment on whether or not house prices seem ‘too high’ in the four countries shown.
Whether or not house prices are ‘too high’ is a subjective judgement. However, ‘too high’ might be interpreted as the house price-to-income ratio being above - or well above - some long-run average. On that basis, German house prices do not look too high, as the index value in the chart has been below 100 during the whole period shown. Prices in the USA seem to have been high at the start of 2006 (when the index was above 100) but have not been too high from 2008 onwards. UK house prices seem to have been high during the whole period (as shown by an index value that is persistently above 100), especially in late 2007 and again in the most recent year or so. Similarly, in Sweden, house prices seem to have been persistently high: since 2013, they might be described as too high with the house price-to-earnings ratio nearly 60% higher than its long-run average by 2017.
It is not possible to compare affordability between countries using this indicator because the actual value of the long-run average of the ratio for each country is not known.