Singapore Centre for Applied and Policy Economics

Estimating bubbles and affordable housing price trends: A study based on Singapore by Tilak Abeysinghe and Jiaying Gu

Department of Economics SCAPE Working Paper Series Paper No. 2013/01 February 2013
http://www.fas.nus.edu.sg/ecs/pub/wp-scape/1301.pdf

 Estimatingbubblesandaffordablehousingpricetrends: AstudybasedonSingapore
TilakAbeysinghea,*andJiayingGub DepartmentofEconomics NationalUniversityofSingapore AS2,1ArtsLink,Singapore117570 Email:tilakabey@nus.edu.sg,Ph+6565166116 DepartmentofEconomics UniversityofIllinoisatUrbanaChampaign IL61820,USA Email:gu17@illinois.edu February2013 Abstract
Policy makers often impose some cooling measures on the housing market when housing prices rise fast. Such policies yield limited success if housing prices are driven up by fundamentals. A fundamental price trend may not necessarily be an affordable one. Unaffordable housing price trends increase the mortgage burden of households. Estimating these different price trends provides valuable information to policy makers. This paper presents an empirical methodology to separate out a housing price trend into fundamental and affordable components. The gap between actual and fundamental trend is attributed to expectations driven persistence of housing price inflation. This is the component that cooling measures are usually aimed at. Affordable housing price trend is defined in terms of a measure oflifetimeincome.Affordabilityrequiresthehousepricetolifetimeincomeratiotobestationarywitha certainmean.Fundamentalsneedtobeadjustedtoobtainthisoutcome.AnalyzingSingaporedatausing thismethodologyrevealssomeinterestingobservations. KeyWords:Fundamentalhousingprice,affordablehousingprice,lifetimeincome,counterfactual simulations JELClassification:R21,D31. *Correspondingauthor,TilakAbeysinghe
b a

1.Introduction
Although house prices are well known to form bubbles, separating the bubble and nonbubble components is a challenging task because of the difficulty of working out a reference price level that representstheunobservednonbubblecomponent. Therearevariousdefinitionsofassetpricebubbles but from an operational point of view we align with those who define bubbles in relation to some fundamental variables (see Siegel, 2003 for some references). By this definition the fundamentals determine the nonbubble component of the price level. One question is how to estimate this fundamentalpricelevel.Apriceleveldeterminedbythefundamentals,however,maynotnecessarilybe an affordable price level. For example, population pressures tend to drive city house prices well above affordable levels. Another important question, therefore, is how to determine an affordable housing price level. The objective of this exercise is to develop an empirical methodology to answer these two questionsandanalyzehousingpricedatafromSingapore. Singapore is an interesting case study in this regard. The country has a small private housing sector and a large public housing sector with private ownership. Singapore has one of the highest home ownershiprates(about90%)intheworld.Singaporegovernmentdesirestoseehousepricesappreciate over time at an affordable rate. Through home ownership the government is trying to achieve a social objectiveofheartlandfeelinginthisglobalcity.Despiteregularinterventionsbythegovernment, 1 the Singaporehousingmarkethasgonethroughanumberofpricecycleswithpricesescalating waybeyond any expectation. Persistent unaffordable increase in housing prices may bring about unexpected negativeconsequences.Forexample,AbeysingheandChoy(2007)observedthatinSingaporeincreasing housing wealth as a result of increasing housing prices does not create a positive impact on consumption expenditures because of a lack of monetizing opportunities of housing wealth. They
SeeGu(2008)andLum(2011)forareviewofSingaporegovernmentpoliciesinthehousingmarket.

observed, however, that increasing housing prices render a substantial negative effect on consumption expenditures leading to a substantial secular drop in average propensity to consume (APC). This has exposedtheeconomymoretovolatileexternalforces.YiandZhang(2010)observedthatrisinghousing prices in Hong Kong as a major cause for the precipitous decline of the states total fertility rate (TFR). Abeysinghe(2011)notedsimilarresultsforSingapore.Thenegativeimpactofrisinghousingpricesmay not be limited to these areas. When house prices appreciate it is not clear exactly what drives the appreciation,fundamentalsorsomethingelse.Inthisrespecttheresultsofthispaperprovideimportant guidelinestothepolicymakers. There is a sizable literature on modeling residential property prices. Under the socalled first generation models pioneered by Muth (1960) followed by others like Smith (1969) stock and flow demand for housing was modeled under the assumption of a highly elastic housing supply. Obviously these models underwent the scrutiny of others for many shortcomings. This gave rise to further improvementsunderthenextgenerationmodelsthatusedeitherthestockflowframeworkortheasset pricing approach. This led to incorporating more comprehensive measures of user cost of housing, supplysidefeatures,disequilibrium,demandsideexpectations,supplysideexpectations,housevacancy rate specifications, and land supply issues. 2 We incorporate some key features of this literature to our modeling strategy but depart from the literature in the way we address the two main questions raised earlier. The methodology of estimating the fundamental housing price trend is discussed in Section 2.1. Since buying a house is a long term commitment, housing affordability has to be measured in relation a measure of permanent income. The income measure we propose is lifetime income and the methodology of obtaining estimates of lifetime income for different income deciles is presented in
2

Tociteafew:Poterba(1984),CaseandShiller(1987),Smith,RosenandFallis(1988),TopelandRosen(1988), MankiwandWeil(1989),DipasqualeandWheaton(1994),MayerandSomerville(2000),MalpezziandMaclennan (2001),HwangandQuigley(2006).Gu(2008)providesanextensiveliteraturereview.

Section 2.2. We propose to measure housing affordability in relation to the growth rate of lifetime income. Section 3 provides a description of computational methods of the variables used in our regressions.Readersmayskimthroughthissectiontopickupthevariablenotationsandmoveontothe empiricalresultsofsections4and5directly.Section6providesa summaryof themethodologyand the keyfindingsfromtheanalysisoftheSingaporehousingprices.

2.Methodology
2.1Estimatingthefundamentalhousingpricelevel There are three price levels that we need to consider, equilibrium housing price, fundamental housing price and affordable housing price. Equilibrium housing price is usually expressed through a present value relationship that is often used to model house pricetorent ratio (Meese and Wallace, 1994; Schreyer, 2009; Igan and Loungani, 2012). Holly et al. (2010) converted this relationship to a housepricetoincomeratio.Thistransformationrequiresthepriceincomeratiotobestationary.Aswe shall see later, the priceincome ratio is unlikely to be stationary in situations where housing affordability has been deteriorating. To remove this nonstationarity we have to introduce other fundamentalvariablesintothemodel. In a simple one period setting the equilibrium housing price is obtained by equating the expected rate of return from home ownership to the rate of homeowner cost of capital (Meese and Wallace, 1994).Inordertomodellogtransformedvariablesitwouldbeeasiertoworkwiththeloglinearpresent value formulation that Campbell and Shiller (1988) introduced for financial assets. 3 To stick to the same symbols let pt = ln Pt be the log of house price and d t = ln Dt be the implicit rental (dividend) for
3

SeeCochrane(2005)foratextbooktreatmentandCampbell(2008)andEngstedetal.(2012)forfurther assessmentsofthetransformation.

owner occupied housing. When the pricerent ratio is stationary the CampbellShiller approximation to log return is

rt +1 = ln[( Pt +1 + Dt +1 ) / Pt ]

k + pt +1 + (1 )dt +1 pt

k ( pt dt ) + d t +1 + ( pt +1 dt +1 ) ,where = 1 / (1 + P / D ) and k isaconstant.Here P / D isthe

steady state level of the pricerent ratio. In equilibrium the rate of return is equal to the rate of homeowner cost of capital. Therefore, writing the above equation for pt d t , solving forward and takingexpectationleadstothepresentvalueformulation:

pt dt = k / (1 ) + Et j 1 (dt + j rt + j ) j =1

(1)

where Et indicates expectation conditional on information at t. This fundamental bubblefree formulation shows that the pricerent ratio, apart from the constant term, is the discounted present valueoftheexpectedrentgrowthrateadjustedforthehomeownercostofcapital. In general pt and dt are I(1) variables and the formulation in (1) requires pt d t to be I(0). Although the priceincome ratio is our primary focus as in Holly et al. (2010), it may not be an I(0) variable as in the case of Singapore. We can, however, replace dt with xt , where xt is a vector of fundamental variables, including income, such that pt xt is I(0). 4 The expectation term in (1) involvesI(0)variableswhicharenotobserved.Bothrationalexpectations(HansenandSarget,1980)and extrapolative expectations (Lansing, 2006, 2010; Granziera and Kozicki, 2012) show that the expected term in (1) can be replaced with relevant observed I(0) variables. Therefore, we can formulate a more generaleconometricmodelwithinthecointegratinganderrorcorrectionmodel(ECM)framework.

Usuallythesevariablesareexpressedinrealterms.Theinflationeffect,however,cancelsoutintheformulation in(1).Apartfromthis,weprefermodelinginnominaltermsbecausetheconsumerpriceindex(CPI)tendsto increasewhenhousepricesincreaseandtherealhouseprice(P/CPI)tendstobeoverdeflatedespeciallyduring housingpricebubbles.

Our first question is how to estimate the long run price level based on its fundamental

determinants. Let pt* = 0 + xt be the long run (log) price determined by a k1 vector xt of the fundamentalvariables.Asmentionedabove,werequire

pt = 0 + xt + ut

(2)

to be a cointegrating relationship such that ut ~ I (0) . Although we can obtain the estimates of the

+ x is not the t = parameters in (2) either using OLS or some other method, the predicted price p 0 t

pt* that we are looking for. Since these parameter estimates are obtained such that

= 0 the

t line predicted price line will pass through the center of pt line. When price bubbles are present the p
will invariably lie above the pt* line. 5 This does not help us in gauging the price gap ( pt pt* ) that wouldbeofpolicyinterest. Onewaytoestimate pt* istospecifyanECMoftheform
p p

pt = 0 + i pt i + zt + ji x jt i + [ pt 1 xt 1 ] + t
i =1 j =1 i = 0

(3)

where zt is a vector of shortrun determinants of house price inflation such as the indicators of speculative activities in the housing market. The lagged dependent variables, pt i , capture the short run persistence of housing price inflation. Such persistence may result from price expectations. When housepricesarerisingfastthebuyersmayrushtobuyahousebecauseofthefearoffurtherincreasein price,whichwilldrivepricesfurtherup.Whenhousepricesarefallingbuyersmaydelaythepurchaseof a house with the hope that the prices may fall further, which will accentuate the price fall. Such

Theoppositewillhappenifnegativebubbles(troughs)aredominant.

persistence may cause short run deviations of housing price from the fundamental price or may even leadtotheformationofpricebubblesthroughtheinteractionofotherfactors(Glaeseretal.,2008). If (3) is well specified, a dynamic simulation using the full model in (3) will track the actual pt very

closely. If we set i = = 0 what is left in (3) are the fundamental determinants of the house price inflation.Wecanthereforeobtain pt* as
p

p = 0 + (1 + ) p + ji x jt i xt 1 .
* t * t 1 j =1 i = 0

(4)

Given 1 < 0 , a dynamic simulation using (4) will yield a long run price that will converge to the
* same price pt* regardless of the starting point p0 . The trend of the price line is determined by that of

xt .
While pt* is determined by fundamental demandsupply forces there could be another price level

pt** that could be deemed desirable in terms of sustaining housing affordability. When demand
pressure outstrips the supply, pt* will rise faster than pt** . Obviously a persistent positive gap of

( pt pt* ) or ( pt pt** ) indicates a buildup of household mortgage debt. We can define pt** as the
price level that renders ln( Pt / Yt ) stationary. Here Yt is a measure of household income. In other words, ln Pt should share the same trend as that of ln Yt . In this context what measure of Yt that we shouldconsiderbecomesimportant. 7

2.2Estimatinglifetimeincome(W)forassessinghousingaffordability A convenient choice for income is per capita disposable income ( Yd t ). One problem of using this in theassessmentofhousingaffordabilityisthat Yd t isameasureofaverageincome.Asincomeinequality increasestheaverageincomebiasestowardshigher income groups.Amorerobustchoice wouldbe the median income, or some quantile measures of income. 6 Another problem of using Yd t is that Pt / Yd t does not correspond to the often used mortgage payment to income ratio for affordability assessment. Both these measures focus on short run affordability. For this reason Abeysinghe and Gu (2011) have proposedalifetimeincomemeasure( Wt )andusedtheratio Pt / Wt toassesshousingaffordability.This ratioundersomeconditionsisthesameasthestandardmeasureofmortgagepaymenttoincomeratio; butithassomeadvantagesoverthelatter.Typicallyapriceincomeratiolessthan30%istakentomean affordablehousingprices. Lifetime income is the discounted present value of the future income stream of a household or an

individual.Forthiswerequiretheageincomeprofileofahouseholdoranindividual.Whenincomedata by age and year are available it is possible to trace the income of the same birth cohort as they age. However, given the limited data available, complete ageincome profiles can be constructed only for a few cohorts. Incomplete ageincome profiles have to be filled using predicted values from a regression. TheregressionthatAbeysingheandGu(2011)adaptedfromMoffitt(1984))toestimatetheageincome profileofarepresentativehouseholdinabirthcohortcanbewrittenas:

yit = 0 + 1 Agei + 2 Agei2 + k = 2 k Ck + it

A+T 1

(5)

Ifincome(y)islognormallydistributedorlogofincomeisnormallydistributedwithmean andvariance ,
2

andMedian(y)=Md(y)= e .Thisgives, E ( y ) / Md ( y ) = e andasthevarianceoflog then E ( y ) = e incomedistributionincreasesthemeandepartsfromthemedianattherategivenabove.

+ 0.5 2

0.5 2

where i=1,2,,A is the ith age representing year in index form, t=1,2,,T is the tth year index, k=Ai+t is the kth cohort index, Ck s are cohort dummies and yit is the log of average household income. Note that the income data for (5) are arranged in a panel format, for each age i, t=1,2,,T. The quadratic age term captures the usually observed humpshaped ageincome profile of a household. The cohort dummiesallowforshiftsintheageincomeprofilefromonebirthcohorttoanother. If income by household is available annually then the quantile regression technique proposed by Koenker and Bassett (1978) can be used to obtain quantile coefficient estimates of (5) and then derive the quantile ageincome profiles. The income data available to us are in deciles (see Section 3) and we cannot use the quantile regression techniques directly. However, Chamberlain (1994) has shown that whentherighthandvariablesoftheregressionarediscrete(asinthecaseofourregression5)theleast square method on groupspecific quantile summary statistics provides consistent estimators for the regression quantile coefficients and they are asymptotically normally distributed under mild regularity conditions (see Bassett et al., 2003 and Chetverikov et al., 2013 for further developments and applications).Wecan,therefore,estimate(5)oritsvariantsdiscussedbelowbyOLSfordifferentincome decilestoobtainthequantileageincomeprofiles. Usually income data are available by age groups, say L years (usually L=5). To correspond to this we have to convert years also into L year groups. If A and T are taken to be multiples of L, then there is a total of (A/L)(T/L) observations to estimate (5) with (A+T)/L1 cohort dummies. This grouping provides ageincome profiles of different birth cohorts also at Lyear intervals. Abeysinghe and Gu (2011) followed this estimation method and used the spline interpolation method in SAS to obtain an annual seriesoflifetimeincomevalues. An alternative method is not to group years into fiveyear intervals,but to introduce enough cohort dummies to estimate the ageincome profile at yearly intervals. Under this setting there are (A/L)T 9

observationstoestimate(5)withA+TLcohortdummies.Onedisadvantageofthealternativemethodis that the number of observations available for estimating the cohort coefficients of the older and younger cohorts drops substantially leading to more volatile cohort coefficient estimates. Since we expect the lifetime income to move smoothly among the consecutive cohorts we suggest applying a smoothing filter to the annual cohort coefficients. In this exercise we use a spline smoothing method. Fig. 1 shows the annual cohort coefficient estimates from our alternative methodology and their smoothedvaluesforthemedianincomegroup.

8.0 7.8 7.6 7.4 7.2 7.0 6.8 6.6 6.4 6.2 6.0 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981

Birthcohort

Fig.1.Cohortcoefficientestimatessolidlineandtheirsmoothvaluesdashedlineforthe medianincomegroup

10

3.Dataandcomputationmethodsofvariables 7
Residentialpropertyprice(P) Singapores residential property market has three major segments, private housing, new public housing and resale public housing. Private housing caters mainly to high income groups. Public housing in Singapore is provided by the Housing and Development Board (HDB) and is also known as HDB housing. New HDB houses are sold to Singapore citizens at a highly subsidized rate. After five years of owner occupation these properties can be sold in the open market. This is known as the HDB resale market. Price data of new HDB properties are not available. Therefore, we study only the private and HDB resale housing prices. Even for these markets sufficiently long time series are available only for median housing prices. The Urban Redevelopment Authority has published a quarterly private housing price index since 1975 and the HDB has published a quarterly HDB resale price index since 1990. We converted these indices to price levels using median price levels of 2005. Fig. 2 presents the private and HDB median housing prices. The large price gap between the two markets and upward trend of prices withcommoncyclesaresomeobservationstobenoteddown.

UnlessotherwisespecifiedthemainsourceofdatausedinthestudyistheSTSdatabaseoftheDepartmentof Statistics,GovernmentofSingapore.

11

1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 1975 1976 1978 1979 1981 1982 1984 1985 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008 2009 2011 PPrivate PHDB

Fig.2.PrivateandHDBmedianhousingprices(Singapore$) Housingstock(HS) Because of data limitations on the number of housing units available, we constructed quarterly housing stock series from constant dollar investment in private and public housing markets using the perpetualinventorymethod.Thisinvestmentbased housingstockaccountsforqualityvariationinunits and also contains supplyside expectations. We lagged the HDB series by five years because the new HDBunitscanbesoldonlyafterfiveyearsofowneroccupation. Population(POP) Population data are available on an annual basis. Singapores resident population consists of Singapore citizens and permanent residents. This component changes slowly and smoothly. We therefore, used the spline interpolation method in SAS to obtain the quarterly resident population. The most volatile component of the population is nonpermanent residents. A large proportion of this population is foreign workers. We used the labor force data that are available quarterly to construct a

12

quarterly series of working age foreign worker population. The total population is the sum of these two components. In the private housing price equation we used the total population. In the HDB price equation we used the resident population because HDB houses can be bought only by Singapore residents. Lifetimeincome(W) We obtained average household nominal income by age and year by income deciles from the Department of Statistics, Government of Singapore. Age is for the household head and is grouped into fiveyearintervals.Annualdataareavailablefrom1990.Datafrom2000onwardsareavailablewithand without employers Central Provident Fund (CPF) contributions. The ratio of income with CPF to income without CPF is about 1.1. We multiplied the data prior to 2000 by 1.1 to adjust them to match the income data with employers CPF contributions. We then used the alternative methods described in Section 2.2 to construct ageincome profiles by birth cohort for each income decile. We then obtained the discounted present value of household income over age 3064 using the discount rate of 5% and constructed the lifetime income series by birth cohort; birth year plus 30 becomes the reference year. AsinAbeysingheandGu(2011)weuseage30astheageatwhichayoungcouplelooksforaresidential property unit. We denote the lifetime income series thus constructed by W1, W2 ,W9 to refer to the defiles 1 to 9. To convert these annual series to quarterly we used the spline interpolation available in the SAS software package. Fig. 3 presents these lifetime income series and it highlights the widening incomegapbetweenthelowerandhigherincomegroupsthatisofinterestforaseparatestudy. 8

NotethattheseriespresentedinFigure4ofAbeysingheandGu(2011)areinrealtermswhereasthoseinFig.3 inthispaperareinnominalterms.Moreover,theincomeseriesofthisstudyincludesemployersCPF contributionsthatwerenotavailabletoAbeysingheandGu(2011).

13

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 W9 W8 W7 W6 W5 W4 W3 W2 W1

Fig.3.Estimatednominallifetimeincome(Singapore$mn)of30yearoldcohortsbyincomedeciles Savings By age 30 households have some savings that need to be added to the discounted present value of the future income stream to obtain the complete lifetime income of a household. Constructing meaningful savings series by income deciles from quinquennial household expenditure surveys is not easy. We, therefore, use quarterly per capita CPF balances (overall) in nominal terms to represent accumulated savings. Disposableincome(Yd)andDeposits(Depst) Lifetime income is a slowly changing quantity (Fig. 3). Therefore, to capture short run effects of income changes we use per capita nominal disposable income and residents deposits. Disposable income is calculated as in Abeysinghe and Choy (2007): GDP taxes government fees & charges net CPF contributions.About60% ofthefinancialwealthofSingaporeanhouseholdsis made upofCPFbalances

14

and residents deposits. Our empirical analysis shows that between the two the CPF balances is the key longrundeterminantofhousingpricesbutdepositsmayhavesomeshortruneffects. Usercostofhousing(UC) Inempiricalexercisestheusercostofowneroccupiedhousing(therateofhomeownercostofcapital)is oftendefinedas (6)

UC = [(1 m )(i + p ) + ]

where m is the marginal income tax rate, p is the property tax rate, i is the nominal mortgage interest rate, is the depreciation rate which may be broadly defined to include other maintenance costs, and is expected capital gains (DePasquale and Wheaton, 1994; Igan and Loungani, 2012). The marginalincometaxrateisincludedintheequationbecausepropertytaxesandmortgagepaymentsare taxdeductible. Constructingtheusercostofhousingisproblematicbecauseofthedifficultyofmeasuringexpected housing price appreciation . Since house prices are subject to bubbles, the use of some averages or projections based on observed housing price to represent expectations in the UC formula tend to producehighlyvolatile UCserieswithimplausiblenegativevalues(Schreyer,2009). Researcherson this problem have found that the trend movements of the consumer price index (CPI) as providing a much better measure of long term house price expectations (Poterba, 1992; Schreyer 2009). In our exercise we also use the trend movements of the CPI inflation rate to measure the baseline house price expectations. After some experimentation, the baseline CPI inflation rate was obtained by simple exponentialsmoothingwith =0.2.

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The marginal income tax rate in the UC formula was calculated as the incomeshare weighted average of the marginal tax rates. Let i be the marginal income rate for the ith income bracket i=1,2,,k, Yi be the assessed income of the ith income group, and wi be the income share of the ith group.Thentheaverageofthemarginalincometaxrates, m ,canbewrittenas:

m = wi i =
k i =1

Yi i
i

Total tax assessed Total assessed income

where wi = Yi / Statistics.

Y .TotaltaxassessedandtotalassessedincomeareavailableintheYearbookof
i

As for the mortgage interest rate i we use the average housing loan rate compiled by the Department of Statistics. This is available since 1983. For the period before 1983 we use the prime lending rate. For HDB housing we take the weighted average of the housing loan rate and HDB concessionary home loan rate with a weight of 0.75 for the former. We set the annual value of to 0.03.TheUCseriescanbecomputedfrom1976Q1andshowsadownwardtrend;itdroppedfrommore than14%in1986tobelow1%bytheendof2012. SubsaleRateandForeignOwnershipRate AnimportantindicatorofspeculativeactivitiesintheprivatehousingmarketinSingaporeisthesub sale rate. This measures how frequently a new residential unit under construction is sold before its completion. This data series is available only from 1995Q1. Another variable that is alleged to cause largepriceupswingsistheinflowofforeign capital tothe privatehousing market (Lum,2011;Liaoetal. 2012). Time series data on capital inflow is not available. As a proxy we use the proportion of uncompleted private residential units purchased by foreigners. These data are available only from

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1996Q2.

4.Fundamentalhousingpricetrendsandbubbles
To estimate long run housing price trends determined by the fundamentals we first formulate the cointegratingregression(2)as:

ln( Pt / Wt ) = 0 + 1 ln( HSt / POPt ) + 2 ln CPFt + 3UCt + 4UC.Dum08 + ut

(7)

The variables in (7) were defined in the previous section (see also notes to Table 1). 9 Following DePasquale and Wheaton (1994) HS/POP represents a given stock of housing supply per capita. As mentioned in the previous section our investmentbased housing stock measure contains supply side expectations.Theothervariablesrepresentdemandsidefundamentals.Unitroottestsindicatethatthe variablesin(7)canbeassumedtobeunitrootprocesses.Dum08in(7)isastepdummythattakesvalue 1 from 2008Q1. The recursive OLS estimates of 3 become less stable after 2007 because of a sharp drop in the UC variable. With the interaction variable, UC.Dum08, the recursive estimates of all the coefficientsof(7)becomehighlystable. 10 Sincewehaveonlythemedianhousepriceswewantedtoassesswhichlifetimeincomevariablesto be used in the regression. We first carried out a residual based ADF test for cointegration over the sample period 19762007 without the dummy. Since private housing in Singapore is for high income groups we used the income variables from W5 to W9 in (7) for this test. We find that cointegration cannotberejectedatthe10%levelonlyforthehighincomegroupsW8andW9.AsforHDBhousingwe carried out this test for income groups W1W6. The residual based ADF test does not support
9 10

UnrestrictedestimatesshowthatthecoefficientoflnWtcanberestrictedtounity. Tryingtoobtainthecointegratingvectorin(7)throughdynamicmodels(Bardsen,1989;Stock1993;Johansen, 1995)provedunsatisfactorybecauseofthedistortionaryeffectsofpricebubblesontheestimates.

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cointegration for HDB housing prices. This could be due to the shorter sample period 19902007. NeverthelessweestimatedthefullregressionsandcarriedoutsimulationsusingW8forprivatehousing andW5forHDBhousing. The estimation results are reported in Table 1. The coefficient estimates in Panel 1 have the expected signs and their recursive estimates are highly stable. Although the tstatistics of these cointegrating regressions may not follow the normal distribution they, except for that of UC, are substantiallylargerthanthestandardcriticalvalues.RecursiveestimatesoftheECMsincolumns(1)and (3) in Panel 2 are also stable and meaningful although some residual diagnostics fail. We retained only thestatisticallysignificantestimatesintheseregressions.AlthoughtheADFtestrejectscointegrationfor HDB housing price, the adjustment coefficient of the EC term indicates that it is a cointegrating relationshipthoughthetstatisticisnotaslargeasthatfortheprivatehousingprice. 11 Column(2)inthe tablewasconsideredtoexaminetheeffectoftwoadditionalvariables(seebelow).Despitethereduced samplesizetheestimatesincolumn(2)arenotverydifferentfromthoseincolumn(1).

11

ResidualbasedADFtestforcointegrationiswellknowntohavelowpower.

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Table1.RegressionestimatesforprivateandHDBhousingprices Private Panel1:Cointegratingregression (1) Deptvariable Constant (2) tstat 0.67 14.6 17.5 1.88 6.41 0.82 SameasCol(1) Coeff 18.63 3.55 1.37 0.02 0.09 (3) HDB

ln( Pt / W 8t )
Coeff 0.26 1.58 1.45 0.02 0.10

ln( Pt / W 5t )
tstat 11.2 13.7 13.2 1.23 4.28 0.71

ln( HSt / POPt ) ln CPFt UCt UC.Dum08t

R
2

Panel2:Errorcorrectionmodel Deptvariable Coeff Constant 0.02 0.64 0.07 1.62 0.43 0.19 0.22 0.63 test 1.64 2.72 21.50 1.53 1.87 0.68 pvalue 0.1537 0.0325 0.0000 0.1212 0.0130 0.4124
th

ln Pt
tstat 2.93 11.1 4.24 2.43 3.51 1.99 2.26

ln Pt
Coeff 0.02 0.57 0.06 1.13 0.44 0.22 0.22 0.002 0.002 Test 1.59 0.89 40.37 0.96 0.54 tstat 2.49 6.89 2.98 1.42 3.88 2.11 2.00 1.65 1.63 0.72 pvalue 0.1927 0.4756 0.0000 0.5195 0.4673 test 1.50 0.24 44.06 1.02 0.99 0.08 Coeff 0.02 0.58 0.07 2.20 0.26

ln Pt
tstat 2.33 7.11 2.66 2.8 2.5 0.52 pvalue 0.2003 0.9174 0.0000 0.4351 0.4914 0.7767

ln Pt 1 ECt 1 ln HSt ln POPt ln Depstt 1 ln Yd t ln Ydt 1 SubsaleRatet ForeignOwnershipRatet 1

R
2

Residualdiagnostics AR ARCH Normality Hetero HeteroX RESET Sampleperiod

1976Q12011Q4

1996Q22011Q4

1990Q12011Q4

Note: P=median housing price, W5=household lifetime income of 5 income decile, W8=household lifetime income of 8th income decile, CPF=per capita Central Provident Fund balances, HS=housing stock, POP=population, UC=user cost of housing, Depst=per capita residents deposits, Yd=per capita disposable income, EC=error correction term OLS residuals from the cointegratingregression.ResidualdiagnosticsarethosereadilyavailableinPcGive.

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 It is worth highlighting some observations that emerge from Table 1. First, for HDB housing the coefficient of per capita housing stock is much larger in absolute value than that for private housing. Althoughthiswasnotexpectedapriori,thisseemstocapturethefactthatHDBcaterstomorethan80% of the Singaporean households. Therefore, one percent increase in per capita housing stock is likely to haveamuchbiggereffectonHDBhousingpricescomparedtoprivatehousing.Second,shortruneffects ofhousingstockgrowthandpopulationgrowthseemtomanifestdifferentlyinprivateandHDBmarkets (Panel 2). It appears that short run fluctuations in population affect private housing price inflation and not HDB. This is understandable because HDB units cannot be bought by foreigners and they are also subject to renting restrictions. On the other hand, an increase in the HDB housing stock lowers the HDB housing price inflation both in the short run and long run. Third, the effects of the subsale rate and foreign ownership rate are not statistically significant. This is partly due to the reduced sample size. The subsale rate picks up the speculative activities in the housing market. It dropped sharply after government interventions in the housing market in 1996. Since then speculation in the housing market has remained subdued and the insignificant effect for the subsale rate seems to reflect this. Foreign ownership rate, on the other hand, does not seem to be picking up the full impact of foreign capital inflowtotheprivatehousingmarket.Tostimulatethehousingmarketoutofitsslumberduringthemid 2000sthegovernmentrelaxedtherulesofforeignownershipofresidentialpropertiesinSingapore.This led to a substantial pick up in housing prices subsequently and the government had to tighten the rules again(Lum,2011;Liaoetal.2012).Ourproxyvariabledoesnotpickupthiseffectwell. Fig. 4 shows the actual median private housing price and the fundamental price trend simulated fromregression(1)inTable1basedontheformulationin(4)usingstartingvaluesfrom1977Q1andQ2. Fig. 4 also shows a simulated (dotted) line with starting values from 1995Q1 and Q2 to highlight that it converges to the same trend line regardless of the starting values. Fig. 5 shows the simulated trend line 20

for HDB median housing price. Housing price bubbles are clearly visible from these figures, one in the early 1980s and the other in the mid 1990s. Government interventions pricked the bubble of the 1990s thatresultedinadecadelongdownwardpriceadjustmentbeforepricesstartedtoclimbupagainabove the trend line since 2007. Between 2007 and 2011 both private and HDB housing prices increased by about 12% per year whereas fundamental trend price increase should have been about 7% for private housing and 10% for HDB housing. It seems that the HDB housing price inflation is mostly fundamental driven. Fig. 5 also shows price trend line generated by plugging in W6 to the regression (3) in Table 1. Althoughwe needHDBpricesforthe6thdecilefora properstudy,Fig.5shows thatrecently HDBprices havemovedclosertothepricegeneratedforthe6thincomedecilethantothemediantrend.Thisbrings ustothenextquestionwhetherthefundamentaltrendpriceincreasesareaffordable.

14.5 14.0 13.5 13.0 12.5 12.0 11.5 11.0

SimwithW8

Fig.4.MedianprivatehousingpriceP(inlog,solidline)andsimulatedfundamentalpricetrend (dashedlineW8).Dottedlineusesstartingvaluefrom1995Q1andQ2.

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13.5 13.0 12.5 12.0 11.5 11.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 P SimwithW5 SimwithW6

Fig.5.MedianHDBhousingpriceP(inlog,solidline),simulatedfundamentalpricetrendbasedon medianlifetimeincome(dashedlineW5)togetherwithatrendpricelinebasedonW6(dottedline)

5.Longrunhousingaffordability
The pricetolifetime income ratio P/W is our housing affordability measure. We simply refer to this as the priceincome ratio. Since we have only the median price of private and HDB housing we examine long run housing affordability by the priceincome ratio ( P / Wk )100, k = 1, 2,..., 9 , where k refers to thekthdecileorthecorrespondingpercentile.AnincreaseofP/Windicatesdeterioratingaffordability. As we stated earlier, private housing in Singapore is affordable only by the rich. Therefore, Fig. 6 presents the priceincome ratio for median and higher income groups, P/W5P/W9. Since HDB housing is meant for low income groups, Fig. 7 presents P/W1P/W5. The horizontal line in these graphs at 30% indicatestheruleofthumbvaluebelowwhichhousingisassumedtobeaffordable.Thesefiguresreveal a number of interesting observations. First, housing affordability in general shows a deteriorating trend across all income groups. Second, although housing prices have escalated recently to levels above the

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1996peak(Fig.2),intermsofaffordability,thepriceincomeratioshavenotdeterioratedtothelevelof 1996. For the median income group P/W5 for private housing in 1996 was 93.1% and in 2011 it improved to 52.9%. For HDB units these numbers were 25.8% and 18.3% respectively. In other words, 1996 has been the worst year in terms of housing affordability. Third, recent trends show that median priced private units are only affordable by the top 20% income groups and median priced HDB units are notaffordablebythelow20%.

100 90 80 70 60 50 40 30 20 10 0 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 P/W5 P/W6 P/W7 P/W8 P/W9

Fig.6.Housingaffordabilityforprivatehousing,P/Wformedianandhigherincomedeciles

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100 90 80 70 60 50 40 30 20 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 P/W1 P/W2 P/W3 P/W4 P/W5

Fig.7.HousingaffordabilityforHDBhousing,P/Wformedianandlowerincomedeciles Since2007thepriceincomeratioshavetrendedupward.Wenotedin theprevioussectionthat the median housing prices have increased by about 12% per year between 2007 and 2011 and the fundamentaltrendpriceincreaseshouldhavebeenabout710%.Theaverageannualgrowthofmedian lifetimeincomehasbeenabout4%andthatofthe8thincomedecilehasbeenabout4.3%.Thesearethe rates at which relevant housing prices should have grown in order to sustain long run housing affordability. 5.1Counterfactualsimulations From a policy point of view our framework suggests attending to two components of housing price inflation in order to keep it in line with the growth of the lifetime income. First is to eliminate short run housing price inflation persistence and the second is to adjust the fundamental variables. To eliminate the short run persistence various governments from time to time have imposed various measures such

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as higher downpayments and additional stamp duties. In the case of Singapore, the government has introduced seven rounds of cooling measures on the property market since 2009. These measures obviouslyhaveonlylimitedeffectsifactionsarenottakentoaddressthefundamentals. We carried out a number of counterfactual simulations to see how changes in some fundamental variables would have altered the private and HDB median housing price inflation since 2007. We considered five scenarios by fixing the values for population, housing stock and user cost of housing. ThesehavetobediscussedseparatelyforprivateandHDBhousing. For private housing we used total population. The growth of population is a contentious issue amongSingaporeanswhowanttoseeadrasticreductionintheforeignworkerpopulationinSingapore. In200708Singaporesresidentpopulationgrewbyabout1.6%whilethetotalpopulationgrewbymore than 4.9% before slowing down to about 2% in 201011. Restrictive immigration and work visa policies of the Singapore government are likely to slow down the population growth further. In our simulations we set the annual total population growth rate to 1.5%. To avoid an abrupt change in the simulated values, we allow the population growth rate to steadily decline over the quarters of 2007 and then onwards settle down to 1.5%. The second variable we consider is the housing stock. Singapore government has been releasing more land sites for private sector housing developments and the housing investment growth rate has increased to more than 7% in 2011 from a low of 3.8% in 2007Q1. Further increase in the housing investment growth rate is likely. We, therefore, set this growth rate to 8% in our simulation. As in the case of population growth we allow the rate to increase steadily in 2007 beforesettlingto8%.Thethirdvariableweconsideristheusercostofhousing.ThekeyfactorintheUC is the mortgage interest rate which is market determined and not subject to policy interventions in Singapore. We can, however, expect the interest rates to pick up from their rockbottom values

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presently.OurUCvalueforprivatehousingstoodat6.2%in2007Q1anddroppedto1.7%by2011Q4.In oursimulationswesettheUCvalueto6.2%since2007Q1. As for HDB housing we used the resident population Singapore citizens and permanent residents, PRs.Despitemanymonetaryandnonmonetaryincentivesofferedbythegovernment,thefertilityrates ofSingaporeanshavebeenfalling.AsaresultthegrowthoftheSingaporecitizenpopulationhasslowed downtoabout0.9%peryearsince2005.TocompensateforthisthegovernmenthastakeninmorePRs. From288,000in2000 thePRnumberincreased to541,000in2010beforedeclining to532,000in2011. Because of the unhappiness expressed by Singaporeans on foreigner inflow, the government plan is to restrict the PR population to about 500,000. Had this been a concern in 2006 we could assume that the government would have frozen the PR population at the 2006 level of 418,000. This is a scenario we considerforourcounterfactualsimulationover20072011.ThenextpolicyvariableistheHDBhousing stock. There has been a substantial slowing of the growth of HDB housing investment since the late 1990s;itdeclinedfromabove6%growthtoabout0.5%growthby2006.ThiseffectisfeltintheHDBre sale market five years later because of the restriction that new units can be sold only after five years of owner occupation. The government is currently in the process of increasing the HDB housing supply substantially. For our simulation we set the housing investment growth rate to a modest 3%, the rate observed in 2001 that matters for the resale market in 2006. The third variable is UC; we set this to 2007Q1valueof5.56%. The simulation results are presented in Table 2. The table presents the base line simulation that we presentedinFig.4and5togetherwithothercounterfactualsimulations.Itpresentstheaverageannual median housing price inflation rate over 20072011 in each case and the price gap (actual simulated) orthedollaramountbywhichthemedianpricewouldhavedroppedby2011Q4.Notethatweobtained

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the baseline simulation by removing inflation persistence from our ECM model. The other scenarios presenttheadditionaldropsresultingfromtheadjustmentstothefundamentalvariables. The results in Table 2 show that the population growth policy, at least the way we have set it up, is theleasteffectiveinbringingdownthehousingpriceinflation.Obviouslylimitingthepopulationgrowth rate requires a substantial reduction of the foreign worker population in Singapore. The results in Abeysinghe and Choy (2007) based on a comprehensive macroeconometric model show that a substantial reduction in the foreign worker population entails undesirable outcomes like reduced economicgrowthandhighunemployment.Therefore,theforeignworkerpopulationasapolicyvariable for the housing market has limited flexibility. An increase in the housing stock works more effectively, more so in the HDB market. Therefore, a more desirable policy combination would be a moderate reduction in the population growth and a reasonably higher growth in the housing stock. Obviously a pick up in the user cost of housing to higher levels while the other two policies are in place may bring downthehousingpriceinflationtoaffordablerates.

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Table2.Counterfactualsimulationsover2007Q12011Q4formedianhousingprices Annualhousepriceinflationrate 20072011 PricegapSin$(Actual Simulated)2011Q4

Scenario PrivateHousing Actual 11.7 $0 Simulation: BaselineFundamental,Fig.4 7.01 $160,000 (1)Populationgrowth1.5% 6.38 $193,000 (2)HousingStockgrowth8% 5.81 $234,000 (3)UserCostvalue6.2% 5.72 $241,000 (1)and(2) 5.41 $246,000 (1)(2)and(3) 4.37 $303,000 HDBHousing Actual 12.37 $0 Simulation: BaselineFundamental,Fig.5 10.41 $44,000 (1)PRpopulationfrozenat418,000 9.50 $61,000 (2)HousingStockgrowth3% 5.10 $142,000 (3)UserCostvalue5.56% 7.12 $108,000 (1)and(2) 4.31 $154,000 (1)(2)and(3) 1.23 $200,000 Note:Hosingstockinthisstudyistheaccumulatedhousinginvestment.Medianhousingpricesat 2011Q4forprivateandHDBunitswere$1,28mnand$456,000respectively.

6.Conclusion
Unaffordable increases in residential property prices over a long stretch of time may entail unexpected negativesocioeconomicconsequences.Obviously,longtermhousingaffordabilityhastobeassessedin relation to a measure of permanent income. The income measure proposed in this study is the lifetime incomeofahousehold.ExtendingfromAbeysingheandGu(2011)wehavepresentedawaytocompute lifetime income by income deciles. If housing prices increase at the rate of lifetime incomes long term housingaffordabilityissustained.Otherwise,householdswillbeburdenedbyexcessivemortgagedebts. Any increase in housing prices above this sustainable level may result primarily from a combination of two other forces, other fundamentals (e.g., supply shortfall) and expectations driven persistence of 28

hosing price inflation. We have presented a way to estimate the fundamental driven price level. If housing prices increase faster than the fundamental trend, housing market cooling measures are called for. The gap between fundamental and affordable trends needs to be addressed by adjusting the fundamentals. Applying these methods to analyze Singapore residential property market reveals interesting observations. Some key results are summarized here. 1. Housing affordability measured by the price income ratio shows a deteriorating trend across all income groups although price corrections from time totimehavebroughttheratiounderthe30%cutoffvalue.Recentincreasesinhousingpricesarenotas bad as the 199596 period when viewed from an affordability point of view. 2. With the relaxation of governmentrestrictionsonthehousingmarkethousingpricesstartedtoescalateagainafter2006.Both private and HDB median prices have increased by about 12% per year over 20072011. When we assess how much of this is due to fundamentals, we can attribute only about 7% increase to the fundamentals in the private housing market and about 10% in the HDB market. The HBD price trend seems to be largely due to fundamentals. The gap between the actual and fundamental price can be attributed to housing price inflation expectations that need to be addressed through short term cooling measures. 3. Counterfactual simulations indicate that a moderate reduction in population growth a reasonably higher increase in housing supply can lower the housing price inflation substantially. A pickup in the mortgageinterestrateswillacceleratethedropinhousingprices. Acknowledgements AuthorswouldliketothanktheparticipantsoftheSeventhJointEconomicsSymposiumofFudan university,HKU,Keiouniversity,NUS,andYonseiuniversityheldonJanuary25,2013atNUSfortheir valuablecommentsonthisexercise.

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