Tackling the world’s affordable housing challenge

Decent, affordable housing is fundamental to the health and well-being of people and to the smooth functioning of economies. Yet around the world, in developing and advanced economies alike, cities are struggling to meet that need. If current trends in urbanization and income growth persist, by 2025 the number of urban households that live in substandard housing—or are so financially stretched by housing costs that they forego other essentials, such as healthcare—could grow to 440 million, from 330 million. This could mean that the global affordable housing gap would affect one in three urban dwellers, about 1.6 billion people.

A new McKinsey Global Institute (MGI) report, A blueprint for addressing the global affordable housing challenge, defines the affordability gap as the difference between the cost of an acceptable standard housing unit (which varies by location) and what households can afford to pay using no more than 30 percent of income. The analysis draws on MGI’s Cityscope database of 2,400 metropolitan areas, as well as case studies from around the world. It finds that the affordable housing gap now stands at $650 billion a year and that the problem will only grow as urban populations expand: current trends suggest that there could be 106 million more low-income urban households by 2025, for example. To replace today’s inadequate housing and build the additional units needed by 2025 would require $9 trillion to $11 trillion in construction spending alone. With land, the total cost could be $16 trillion. Of this, we estimate that $1 trillion to $3 trillion may have to come from public funding.

However, four approaches used in concert could reduce the cost of affordable housing by 20 to 50 percent and substantially narrow the affordable housing gap by 2025. These largely market-oriented solutions—lowering the cost of land, construction, operations and maintenance, and financing—could make housing affordable for households earning 50 to 80 percent of median income.

Four approaches can narrow the housing-affordability gap by 20 to 50 percent.

1. Unlocking land supply. Since land is usually the largest real-estate expense, securing it at appropriate locations can be the most effective way to reduce costs. In even the largest global cities, many parcels of land remain unoccupied or underused. Some of them may belong to government and could be released for development or sold to buy land for affordable housing. Private land can be brought forward for development through incentives such as density bonuses—increasing the permitted floor space on a plot of land and, therefore, its value; in return, the developer must provide land for affordable units.
2. Reducing construction costs. While manufacturing and other industries have raised productivity steadily in the past few decades, in construction it has remained flat or gone down in many countries. Likewise, in many places residential housing is still built in the same way it was 50 years ago. Project costs could be reduced by about 30 percent and completion schedules shortened by about 40 percent if developers make use of value engineering (standardizing design) and industrial approaches, such as assembling buildings from prefabricated components manufactured off-site. Efficient procurement methods and other process improvements would help, as well.¹ 1.For more on new construction techniques, see David Xu, “How to build a skyscraper in two weeks,” May 2014.
3. Improved operations and maintenance. Twenty to 30 percent of the cost of housing is operations and maintenance. Energy-efficiency retrofits, such as insulation and new windows, can cut these costs. Maintenance expenses can be reduced by helping owners find qualified suppliers (through registration and licensing) and by consolidated purchasing. For example, buying consortia in the United Kingdom have saved 15 to 30 percent on some maintenance items for social housing.
4. Lowering financing costs for buyers and developers. Improvements in underwriting would help banks safely make more housing loans to lower-income borrowers. Contractual savings programs can help such buyers accumulate down payments and therefore finance purchases with smaller and less risky loans. Such programs can also provide capital for low-interest mortgages to savers. Governments could help cut the financing costs of developers by making affordable housing projects less risky—for instance, by guaranteeing buyers or tenants for finished units.

The successful application of these approaches depends on creating an appropriate delivery platform for housing in each city. Policy makers, working with the private sector and local communities, need to set clear aspirations for housing throughout their cities. Critically, a minimum-standard housing unit must be defined in each of them. But an excessively ambitious minimum can discourage the construction of affordable homes and force more low-income households into informal housing. A better solution is to set standards that reflect rising aspirations—a housing “ladder” that can start with something very basic that might, for example, have communal kitchens and baths and serve as transitional housing for new arrivals.

Affordable housing could represent a significant opportunity for the global construction and housing-finance industries. Building homes for all the low-income households added in cities by 2025 could cost $2.3 trillion. That would represent a construction market of $200 billion to $250 billion in revenues annually, or about 10 percent of the global residential real-estate construction industry.