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1. Scottish Model of Housing Supply and Affordability

1. Introduction

This report is a summary overview of the development, estimation, testing and simulations borne out of the research team's production of a working Scottish (and sub-national) model of housing supply and affordability. The project started only in early January 2008, and finished with an operational model that meets the client's requirements by the end of August 2008. The report is a short final report prior to a longer account of the project. The report should ideally be read alongside the interactive programmed computer simulation model.

1.1 Research Aims and Objectives

The brief provided by the Scottish Government establishes the project's aims and objectives. The aim of the study was to construct a model that allows analysis of the relationship between housing supply and affordability at the national and sub-national levels. This model would provide forecasts and scenario analysis of housing affordability at sub-Scottish geographies and help to inform national housing policy, development planning and the second National Planning Framework. The requirements of the model were that it should be coherent theoretically, make good use of the available data and be based on rigorous economic and statistical methods.

Key inputs set out in the brief revolved around the capacity of the model to investigate the relationship between housing supply and affordability based on central assumptions about future levels of housing supply (within Scotland and by sub-national area). The model would focus on long term trends of at least 30 years (the research team would work with Communities ASD to develop a small number of alternate scenarios). The key output would be affordability measures with provision of median house price to median earnings as the minimum requirement. In fact, the final model provides the ratio of mean house price to mean household income and the ratio of lower quartile house prices to lower quartile household incomes. The brief envisaged these final outputs to be the outcome of a series of interacting equations, or modules, that determine household formation, migration, the labour market, tenure choice and house prices. These are based on a series of connected terms and variables, critically shaped by the relationship between endogenous and exogenous variables. Once tested and operational such a model then allows the research team to simulate forward different scenarios in order to provide robust analysis about affordability and wider housing market/economy consequences of policies and shocks to the system. Moreover, such a model operates at sub-national level and adds up to Scottish level outcomes. The final model, like the Department of Communities and Local Government ( DCLG) one, would operate in Excel in a user-friendly manner, be suitable for wider use by the client, and be intuitive and transparent.

1.2 The Research Process

Led by Dr Chris Leishman, a multi-institutional team was assembled including key inputs from Professor Geoff Meen who led the English DCLG regional affordability model, expert migration input from Professor Robert Wright and spatial input into the sub-national geography by Newhaven Research Limited (Dr Tony O'Sullivan and Gillian Young). The key stages of the work involved, first, careful determination as to what would be possible relative to the ideal model, as determined by data, time constraints and the needs of a fully operational model. Second, this was additionally constrained by the need to have a coherent and robust sub-national geography within which the model could be fully nested and outputs from which could add up to a Scottish level. Third, each module had to be separately developed and estimated before, fourth, the model as a whole could be run and testing, sensitivity analysis and simulation work could be begun. Throughout, the team worked closely with Communities ASD in the Scottish Government and in addition to holding business meetings, ran a workshop on market geography and contributed to the seminar Firm Analytical Foundations. The main constraints to the delivery of the model turned out, not unexpectedly, to be data, but in the end this did not prevent the timely delivery of a multi-module fully estimated simulation model capable of delivering the initial proposed outputs in a user-friendly Excel format.

1.3 The Policy Background

The context for this research involved several reinforcing strands. Communities ASD presented findings in the summer of 2007, and prior to the credit crunch, in their Housing Market Review (Scottish Government, 2007a). This indicated that at the Scotland level, housing supply was not responding to house price growth and that this was an intensifying problem in recent years. In short, there was recognition of a long term build up of affordability problems in the Scottish housing market (and hot spots therein), also reflecting beliefs about the causes of these difficulties ( e.g. restrictive planning on the supply side, behaviour by investors, the tax regime for housing and wider economic drivers, etc). At the same time, there was a growing recognition that the new Scottish Government's ambitions for the economy require a better understanding of its interplay with the housing system. Second, the shock to the housing finance system emerging in the autumn of 2007 has had massive and continuing negative impacts on both the housing market and the Scottish economy. Developing a robust model that can cope with, if not explicitly trace, the plausible impacts of such shocks is an important tool for policy makers and planners who confront the new stylised facts emerging after the credit crunch took hold of mortgage lending.

A third strand might be called the Firm Foundations agenda (Scottish Government, 2007b), following the autumn 2007 publication of the Government's housing policy consultation document of that name. Affordability and access to home ownership were key dimensions of Government thinking and in the light of preliminary analysis by ASD economists, the consultation paper suggested an aspiration to increase total annual housing supply from under 20,000 units per annum to the order of 35,000 completions per annum by the middle of the next decade, on the basis that this was then thought to be a level of supply that would positively (in a social sense), and also sustainably, impact on house price to income ratios. Moreover, the consultation paper also suggested that supply growth should be consistent with the requirements of local or sub-national housing markets but that the analytical input into planning new supply, and the precise volumes of necessary new supply, should be evidence-based and derived in part from the outputs of a new simulation model of supply and affordability - in effect, the development of a comprehensive multi-equation integrated model of the housing market.

A fourth strand of the background concerns learning lessons from England's experience of regional affordability model building. Geoff Meen led a large team that has developed a sophisticated multi-equation simulation model of the 9 English regions in order to measure the achievement of affordability targets and provide scenario simulations. The Scottish model operates at a lower and more functional geography but directly builds on the spirit of the DCLG approach. Professor Meen advised on the Scottish project and this proved invaluable in terms of data issues, Excel programming and various econometric estimation questions.

1.4 The Model and its Spatial Structure

The main report (Leishman et al, 2008) deals in detail with the individual modules and their interaction (and respective endogenous and exogenous components - which in turn allow policy analysts to use the model by shocking or scenario-building with the exogenous variables). Here, the introduction simply describes the main elements of the model, the sub-national geography and the specific simulation exercises run at this stage (as well as what is possible given the existing set-up of the model in Excel).

The main modules constructed for the affordability and supply model are:

• Household formation ( HF)
• Migration ( MIG)
• The labour market ( LM)
• Tenure choice ( TC)
• House price and housing market activity determination ( HSG)

Figure 1 indicates schematically how these different modules interact from the point of view of the household formation ( HF) module. Population projections are largely a function of natural factors but their location is affected by new housing supply. Overall population estimates are also affected by migration and the intra-Scottish patterns of migration, along with the modelled transformation of population into households through endogenous headship rates. Household numbers generated by this module then go on to influence the housing market through demand effects and the labour market through the supply side. Similar interactions are modelled for the other modules.

Figure 1 Household formation ( HF) module flow chart

The modelling framework requires that a number of variables should be treated as endogenous, while others should be assumed exogenous. In practice decisions about the appropriate treatment of each variable (determined in the model or treated as exogenous) depend on their relative importance, data availability and the modelling approach taken to achieve the key research aims and objectives. Variables, such as interest rates, international migration, migration flows to the rest of the UK and natural population change are all treated exogenously. Those endogenously determined within the model include: the relationship between affordability and housing supply, but also intermediate variables such as earnings, house prices, household formation, ownership rates and labour market status.

The second distinctive feature of the model is that it was developed around a robust, sub-national housing market geography. The selection of a suitable unit of geography for the sub-national level of analysis was influenced by a number of criteria, with the final choice reflecting a trade-off between the desire for finely-grained spatial detail, economic coherence and the quality of data at different spatial scales.

Given the strong theoretical economic foundations of the Scottish model of housing supply and affordability, economic coherence is clearly a particularly important criterion. However, there are other relevant arguments and criteria. For example, it is clearly important that the chosen unit of geography be meaningful and useful in political and administrative terms, and it should be possible to access and replicate data at the chosen unit of geography. In the context of this study, economic coherence has two dimensions: spatial and temporal. The latter is relevant because the model is expected to provide meaningful simulations over a significant forward period. It is therefore important that any unit of geography chosen is sufficiently robust over time and is unlikely to quickly become out of date. Considering political, economic and empirical factors jointly, 7 criteria were identified as an aid to the selection of the most appropriate sub-national geography:

• Economic coherence: The sub-national geography should (as far as practicable) reflect functional areas rather than simply rely on administrative area boundaries. By this we mean that the areas identified should have some intrinsic rationale in terms of clear links between where people live and work and the housing choices of households.
• Possible expansion of a Housing Market Area ( HMA) over time: In the last 20 years the numbers of travel to work areas ( TTWAs) in the UK has reduced considerably ^.. Assuming the underlying trend towards more and longer distance commuting continues, the numbers of TTWAs and HMAs are likely to continue to fall. In particular, the boundaries of the city-region HMAs that include local authorities where General Register Office for Scotland ( GROS) project significant population growth are likely to spread outwards.
• Policy relevance: The sub-national geography should be broadly consistent with administrative geography, particularly for the city region areas where strategic decisions on housing, planning, and economic development need to be co-ordinated to tackle problems associated with decentralisation of the urban core, affordability pressures, and various supply constraints.
• Political acceptability: Consideration must be given to the local political acceptability of the proposed sub-national geography provided they do not exclude functional areas that form part of the HMA area.
• Comprehensiveness and clarity of coverage: The sub-national geography should cover the whole of Scotland. The complexity of the model means that it is not practical to define overlapping boundaries and that all parts of the country should be included in a single spatial unit. Thus each spatial unit ( e.g.TTWA or LA area) used as a building block should be allocated to one 'housing market area'.
• Data availability: The variables selected for the econometric modelling work will depend on the availability, relevance, and reliability of secondary data sources. Ideally we would wish to construct the agreed sub-national geography from smallest practical standardised spatial scale (such as datazones or TTWAs). However, in some instances some data may only be collected at or released at local authority ( LA) area.
• Minimum scale: In terms of identifying the sub-national geography it is important to ensure that the selected spatial units contain sufficient population to ensure there is reliable data to permit econometric modelling. We therefore believe that each agreed spatial unit should contain at least 40,000 adults of working age in employment, which we estimate on average is equivalent to a population of around 80,000 or more.

Analysis of housing and labour markets below national level is not a new approach and the choice of sub-national geography therefore reflected the availability of a number of "ready made" potential options. These included the following:

• Communities Scotland / DTZ Pieda housing market areas.
• The proposed strategic development planning authorities (the 4 city regions).
• Scottish Government's six regional enterprise areas.
• NUTS3 areas.
• Local authority areas.
• Travel to work areas ( TTWAs).

The final selection of sub-national geography was aided by a discussion paper circulated by the research team to Scottish Government, followed by a half-day workshop event held at the University of Glasgow. None of the potential spatial frameworks noted above clearly met all 7 criteria and so the choice of geography required careful consideration of the trade-offs between the criteria.

The discussion paper and workshop event identified groupings of TTWAs as a leading option for defining an appropriate sub-national geography for urban and commuting areas in Scotland. Groupings were based on patterns that most closely matched Communities Scotland's HMAs for the four city regions. This is consistent with previous studies (see for example Halden, 2002) that suggest there is a reasonably close relationship between the boundaries of HMAs and TTWAs.

The major difficulty with these proposed groupings is that not all variables needed for the economic modelling work are available at units of geography below local authority level. In addition, the discussion at the geography workshop emphasised the importance of selecting a unit of geography that yields boundaries meaningful to local authorities while, at the same time, retaining the concept of larger scale "sub regional", rather than local authority, boundaries. The solution involved the combination of economic with political, empirical and pragmatic factors and this yielded the geographical units shown in Table 1:

Table 1 Local authority components of the sub-national geography

1.5 Simulations

Once the model is estimated and operational (no small task!), the core task is to simulate alternative scenarios regarding the effect of additional supply (net additions to the housing stock) given to the research team. The key question is what would this do to supply, affordability, house prices and so on, particularly in comparison with a base scenario. Three scenarios were identified for detailed analysis for the purpose of this report.

1. Growth rate of dwellings in each sub-area from 2002 to 2006 continue for the entire projection period (base case).

2. Net additions to the stock increase each year on the 2002-06 growth rate until they reach the level associated with 35,000 completions per annum (2017); thereafter annual net additions are held at this level.

3. Net additions increase as in Scenario 2 to 2017, but thereafter additions fall back to current levels over a ten year period and then remain at that level for the rest of the projection period.

These scenarios assume that the relative sub-national distribution of net additions remains in line with the distributions observed in the period 2002-2006.

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