Making home ownership possible for more

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House prices in Malaysia continue upwards and there is as yet no sign of a slowdown. With the dream of owning a home growing more illusory for more and more Malaysians, it’s time to rethink housing finance and introduce innovative solutions that will give more Penangites a chance to buy a home.

A growing segment of Malaysian society is unable to buy decent or affordable housing which meets their needs and aspirations. House prices have moved beyond reach for many households and continue to do so, rising faster than household incomes.

Key urban areas such as KL, Penang and Selangor, which provide significant employment opportunities as well as generate and drive economic growth, are typified by increasing levels of “housing stress”; a situation where housing costs (rental or mortgage) are high relative to household income. In Penang, the house price index reached 183.8 in the second quarter of 2012 – an 83.8% increase in prices since 2000 (11.4% higher than the national index), while in a similar time frame (1999-2012) the mean household income has grown by 62%.

These rising house prices are coupled with Bank Negara’s instructions to tighten mortgage lending conditions1 in response to the global financial crisis and to the high and unsustainable levels of household debt in Malaysia. Rising prices, combined with growing restrictions on lending, mean that housing affordability is being squeezed from two directions.

Several attempts have been made to address this. For instance, federal affordable housing schemes such as the My First Home Scheme and PR1MA have been introduced, providing higher loan-to-value ratios (as high as 105%), and guarantees on a fixed deposit (10%) to aid home ownership.

However, this seems a counterintuitive response to Bank Negara actions to address unsustainable levels of debt. By removing any requirement for the household entering owner occupation to have an equity stake, problems of adverse selection and moral hazard are created, which lead to undesired results (e.g. more of the population living with no equity in their homes) and a situation where households can take risks because the largest burden of risks is not borne by the household. The impact of these programmes is also slowed by the length of time it takes to construct and deliver new specified housing units into the market2.

Thus, other solutions are needed.

What is shared equity?

A number of alternative approaches to addressing housing affordability have developed around the world, based upon financial innovations in mortgage lending that challenge the traditional understanding of housing tenure as either “rented” or “owner occupied”.

Known broadly as shared equity, in these models the household shares the capital costs of purchasing a home with an equity partner, which allows households to “buy into” a home with a lower income and with lower equity than would be required under conventional mortgage lending conditions. Such a model can be applied to any house purchase including, potentially, to sub-sale property, which allows impacts to be generated far quicker.

A range of shared equity models has developed which sit between rental and owner occupation and which suit differing housing challenges and deliver differing benefits. These models can be viewed along a bridge that spans between the two established housing tenures, with some models having characteristics that are closer to those attributed to social renting, while others are much more explicit in terms of supporting households to build assets through owner occupation (see Figure 2).

A shared equity loan, for example, is provided for a minority equity share in the property (typically up to 30%) and the household pays a capped interest on the outstanding loan until it is repaid in full. The combined costs of the mortgage and the equity loan interest are, however, lower than the cost of an outright mortgage of the same value. These models further support affordability by reducing the deposit requirement (by up to 30%) as the household only needs to put down a deposit as a percentage of the mortgage loan (e.g. 10%) rather than the overall house price.

These models support households on the edge of owner occupation, and provide enough of a boost to their lending capability to allow them to access affordable mortgage finance.

Shared ownership models further extend the range at which an equity partner can invest, moving beyond minority shares into majority shares and even up to 75% of the equity. But instead of an interest rate being charged on the equity share, a rent is levied (typically two to three per cent of the annual value of the share) leading to a common description of this model as “part buy” and “part rent”.

This translates into a broadening of access, with more households able to access home ownership under this model. Shared ownership models typically have stronger social objectives than shared equity loans and are designed to retain properties in shared ownership status in the longer term and recycle them for social use. Commonly greater restraints are placed on resales.

Equity co-operatives are designed with a more explicit aim to develop housing that is affordable in perpetuity; while house prices continue to rise faster than incomes, the subsidy cost of supporting a household into home ownership will only increase over time. These models address this problem by fixing resale prices based on the growth in incomes rather than growth in house prices, therefore ensuring that a household in the same position in the future would be able to buy the same home, placing this model more in a social housing context, where ownership is for the common good as opposed to what is financially best for the individual.

The benefits of shared equity

The primary benefits of shared equity models for households are the lower entry costs (e.g. lower deposits) and lower monthly financial commitments (e.g. mortgage loan repayments). By increasing the affordability of the household, this also provides greater access, and offers increased choice and higher quality options than a conventional purchase on the open market.

This can allow for a better location – closer to work or school, for example – which itself can have significant social and economic benefits for the household. Shared equity also provides financial benefits associated with the dominant tenure of owner occupation, and while this is limited to only part of the benefits, none of the financial and capital gains of home ownership accrue to tenants. Housing equity represents an important, and often the only, source of personal wealth for many homeowners.

There are psychological benefits as well with shared equity, which come from being associated with the dominant tenure. Tenure conveys a sense of pride, status and advancement for many people. Owning a home is an important source of ontological security in modern society, providing a sense of the reliability of things and place. Those unable to access this dominant tenure feel increasingly detached, and even partial ownership allows households to demonstrate that they are part of the “mainstream”.

Shared equity products potentially provide greater flexibility and present less risk than outright owner occupation. Risks of market fluctuation and interest rate rises are shared with an equity partner, a key difference from approaches which seek to extend lending without any equity stake.

Widening access to owner occupation presents social and economic benefits for society as a whole. It promotes mobility and wealth creation and can support key worker recruitment and retention in high pressured housing markets, which in turn contribute to a stable economy and society.

"In shared equity models, property is typically sold as leasehold with conditions applied to the lease."

The trade-offs

There are, however, trade-offs. The basic tenet of all shared equity schemes is the relinquishing of some aspect of the purchasers’ use and occupation rights in exchange for lower entry costs and monthly commitments – another key difference in current approaches to supporting affordable home ownership. All of these models involve a number of trade-offs in terms of rights and responsibilities, which sets them apart from either rental or owner occupation.

The benefits of lower entry costs and monthly commitments may, consciously or otherwise, mask the attributes that are less well aligned with traditional homeownership, such as control over the management of the property. In shared equity models, property is typically sold as leasehold with conditions applied to the lease.

For example, equity partners will typically retain a right to inspect the property to ensure it is being kept in good condition – yet no physical alterations to the property may be allowed. Furthermore, a shared owner may own only 50% of the property but would still be responsible for 100% of the maintenance and repairs, and further restrictions on the use of the property may be in place, such as restrictions on sub-letting and fixed time periods in which you cannot sell the property. Grounds for repossession contained in leases or scheme regulations could mean shared owners are less secure than traditional owner occupiers, and this overall lack of control presents a much more restricted sense of ownership.

This lack of control extends to the utility of housing as an asset. Equity tied up in a shared purchase becomes “economically sterile” and unable to support business enterprises, for example. Considered as a transitional tenure that facilitates households moving into owner occupation in the longer term, these models have overall higher costs. Full ownership would cost less in the long run, as rent or equity interest charges are still considered “dead” money.

One argument suggests that shared equity models can actually limit social mobility. As households become trapped in the tenure, with the majority unable to raise the additional capital or increase mortgage repayments in the future to buy out their equity partner, they may never reach full ownership (100%). If a household wants to move house or wants to move to a new location where shared equity is not an option, they may be forced into the private rented sector, having not accumulated enough equity to move into full home ownership.

So what sort of shared equity model would be suitable in Penang?

Subsidised homeownership schemes are more acceptable to purchasers the closer the models fit their perceptions of what homeownership means. Penang is a largely owner-occupied society with 75.2% of households in owner occupation compared to 71.4% nationally (Department of Statistics, 2009), which compares internationally to a 60% owner occupation rate in Turkey and just 42% in Germany, for example. Home equity has traditionally played a large role in family welfare, and this would suggest that from the typology of shared equity models, shared equity loans would have the highest level of acceptance in Penang.

"By increasing the affordability of the household, this also provides greater access, and offers increased choice and higher quality options."

While households (and lenders) prefer the shared equity loan model (as it is typically a simpler arrangement), it dictates a higher price point in its targeting and supports those already on the margins of home ownership rather than significantly broadening access.

Shared ownership models provide a greater range of households with opportunities to address their affordability challenges. In the Global Urban Observatory Databases of UN-Habitat, the Price-to-Income Ratio (PIR) of the median household income to the median house price is one of the most important urban indicators. Demographia’s annual housing affordability survey covers more than 200 markets, and its Affordability Rating Categories assess that housing is affordable where the median PIR is 3 or less, moderately unaffordable between 3.1 and 4, seriously unaffordable between 4.1 and 5 and severely unaffordable at 5.1 and over.

In Penang, only approximately 20% of housing are considered “affordable” by this definition, and this is limited to low cost housing not originally intended for the median income household. By extending equity shares to 50%, for example, under a shared ownership model, a greater number of households would be able to access home ownership which meets their needs and aspirations.

"On the island, house prices have increased 135% since the year 2000."

A large and well-known part of the affordability problem on Penang Island is the lack of remaining land for development; the cost of land continues to rise as demand outstrips supply. On the island, the house price index reached 235 in the third quarter of 2012 compared to 183.8 for the state as a whole (Department of Statistics, 2012). In other words, house prices have increased 135% since the year 2000. This problem is further compounded by falling rates of housing stock growth, which places even greater demand on the existing and incoming housing stock. Therefore, prices continue to rise.

While significant investments are being made at state level to build new affordable housing, there is little to protect this housing from the rising market, and some form of price control and resale restrictions will be required. “Affordable” housing will need to be strictly controlled if it is to remain affordable, and just as low cost housing is protected by a “restriction in interest” on the title – which prevents its disposal without state consent – new affordable housing interventions will require similar (stronger) protection. In the context of shared equity, a subsidy retention model such as an Equity Co-operative would be useful in Penang. However, this is some distance from the current perception of home ownership in Penang.

Implementing shared equity in Penang

Developing shared equity models typically takes place at the national level as they require strong government facilitation with new regulations, a clear legal framework and significant public subsidy to stimulate development of these financial models. While shared equity models do not require heavy ongoing government involvement in management terms, the government does need to play a strong role in providing advice, guidance and support to households. Developments in any new financial models need to be clearly communicated to developers, private equity holders, solicitors, estate agents and financial advisors to raise awareness of a new financial product.

Equity markets need to be convinced for shared equity products to become a mainstream offering, with clear investor returns and confidence being key to building scale, and this can only flow from strong government commitment and a setting of the framework. The lack of familiarity on the part of private equity causes shared equity to be judged as a higher risk; regulators require lenders to set aside higher levels of capital against shared equity lending, while the repayment profile of loans injects an additional element of uncertainty.

Given the challenges involved in changing legislation, developing new financial instruments and shifting market attitudes, could a state level approach be developed? Or could a private sector model be developed with no direct public subsidy?

“Retained” ownership models exist where a developer retains an equity share in the property, to be cashed in on resale. Say, a household buys 80% of the property from the developer who charges an annual or monthly fee on the retained share. The developer will then gain a return through capital growth on its retained equity share over time.

State governments in Malaysia have long enforced conditions and charges on development along with housing quotas, with developers required to build 30% low cost units. However, these conditions, charges and quotas need to be revised with a more intelligent understanding of housing requirements at the state level. The conditions placed on private sector development could be reshaped to accommodate the application of a private sector shared equity model. Developers could be required to offer a fixed number of retained equity units (for the state to allocate) as part of their housing quota or in lieu of development charges, for example.

It is conceivable that the Penang Development Corporation (PDC), embarking on a major affordable housing programme, could offer such a model, where households are given an option of buying less than 100% of the unit, bringing the benefits of home ownership to a wider range of households while also developing a revolving fund to support affordable housing, as rental payments are collected and capital gains are made from future resales which can then be recycled for social good. With a sufficient financial pot, shared equity could be offered on application for sub-sale property, reducing the time taken to respond to demand.

The land-use system can be also be leveraged to produce more affordable housing outcomes, and can potentially be used to develop a shared equity approach. Land-use rezoning charges, for example, can be traded for housing equity, and government-owned land can be exchanged for equity in a fixed number of units (which the authorities can then allocate to those on the housing list who are eligible).

Conclusion

The desire for homeownership among many Malaysians is being challenged by financial realities and new models can be considered. The rise of an intermediate housing market (somewhere between rental and owner occupation) has displayed a need for a more diverse understanding of the relationships between people and their housing, and shared equity models present an additional option in addressing the challenges of housing affordability. Such models can play a role in limiting the social and economic polarisation which continues to arise between those on the ladder and those who are not.


This article is adapted from "Shared equity: An innovation for the Malaysian market?" by Stuart MacDonald in Housing the Nation: Policies, Issues and Prospects, Kuala Lumpur: Cagamas Berhad, forthcoming.


1 Bank Negara Malaysia issued guidelines in November 2011 aimed at promoting prudent, responsible and transparent retail financing practices; however, most lenders had already adopted tighter lending criteria. Banks reduced the standard loan-to-value (LTV) ratios, with 100%, 95% and 90% mortgage financing deals being removed, and critically, moving from gross to net in monthly income assessments.
2 Construction period is typically 24- 36 months but the entire housing delivery system requires more like 50 months to deliver units into the market.
3 Jacobs, R. and Lubell, J., (2007), “Preservation of Affordable Homeownership: A Continuum of Strategies”, Centre for Housing Policy Brief.

Stuart MacDonald is a fellow and head of Urban Studies at the Penang Institute.



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