According to UN-HABITAT, all African countries are severely encumbered with the challenge of providing land and affordable housing. Nevertheless, I suggest that inventive solutions to the affordability challenge can easily be formulated by simply making a critical review of the concept of the “affordability gap” and the factors that drive this gap. We normally assume that in perfect markets rental prices are likely to drive house prices up or down. This is an example of an equilibrium relationship in that the rent paid by renters does not significantly exceed the cost of providing such housing services by house owners (this cost is called homeowner’s user cost). Homeowners’ user cost is the extra cost incurred by a homeowner to provide a house to a renter. Homeowners’ user cost includes property depreciation, maintenance cost, property tax, income tax and interest paid on the mortgage finance net of any capital gains. In summary, we can write this relationship for a given period (monthly or yearly) as:
Rent= [(interest+property tax+dep+maintenance)- Cap gains)] x House Price
The central assumption of the above relationship is that when rent exceeds the homeowners’ user cost (right hand side) significantly, the renters will be motivated to switch tenancy either by borrowing and buying or building their own houses. In effect, demand for rental houses will reduce and rents will come down again (alternatively, high demand for mortgage finance will push interest up), which ensures a return to equilibrium in both rental and housing markets.
Nevertheless, as often asked, not everybody can borrow at any time and as much as they want whenever they feel. Therefore they cannot join the homeowners who are making huge profits from their rent payments even when their rent payments easily service a mortgage loan. This is a common phenomenon in Africa and other developing countries where the rental prices are persistently higher than homeowner’s user cost. We say that an affordability gap exists continuously in such countries. Where interventions, such as housing subsidies assist in eliminating the gap, investors and other housing market players have often complained that subsidies can distort the efficient market functioning and scare investors away. However, approaches aimed at addressing the gap using the factors in an equilibrium relationship as discussed above may not affect the market negatively but instead may attract more investments into the market segment as discussed below.
Firstly, a strategy aimed at reducing the cost of housing finance to low-and middle-income builders. Governments can do much to support developers in this segment by facilitating the supply of long-term capital to lenders and developers in this segment at competitive interest rates. Such capital can be distributed through the community based organisations, such as FED-UP in South Africa and SDFN in Namibia or through a specialized lender such as National Housing Finance Corporation Ltd in South Africa. Any action that leads into a reduction in the interest rates will translate into reducing the cost to homeowners which should either translate directly into a reduction in the rental prices or indirectly encourage individuals in this segment to buy their own houses by borrowing from the bank.
In addition, financial products targeting such developers can be introduced with flexible repayment plans or pegged to rental collection or with attractive tax incentives. These types of financial products can perform much better with the middle class in Africa where the majority of home constructions are reportedly being carried on in incremental basis and the bulk of them are not funded by mortgage loans for a variety of reasons. A very interesting product in this set is the Jamii Bora’s tenancy purchase agreement in Kenya. This is where tenants enter into a one year renewable agreement in which their rental payments are equivalent to a 20-year mortgage bond monthly repayment. This means that a tenant can convert his/her tenancy into a house purchase at any time by using the previous rental payments as a down payment. In the same way, a well-structured funding can enable the developer to charge a price for small but decently built houses in which the financing may be repaid at a rate as fair/close to rental payments.
Another strategy could target land and the overall cost to private developers and investors. If the cost of land could be significantly reduced or eliminated, then developers could be encouraged to build houses that can be rented or sold at a lower cost. This approach has been identified as an effective way of addressing housing delivery in China and in some cities in India by UN-HABITAT and by other organisations in developed countries such as Home and Community Agencies in UK .
Additionally, an alternative approach could be the use of tax incentives to developers in this segment. From the mathematical relationship above, property tax could be eliminated completely and even invert the role of tax from a homeowners’ cost into an income by offering additional tax holidays for such developers. In the US, such an approach has been implemented as the federal low-income housing tax credit program (LIHTC) that is credited for increasing production of low-income rental houses
Clearly, the persistence of incremental construction of property projects, increasing rental prices, the growing middle income and the ballooning population of people living in squalid conditions suggests that financial innovation in low-and middle-income segment is necessary. It is much more interesting to note that there are several interventions that could be achieved without distorting the market or using unsustainable approaches as was done in the past.