Every house price index tells its own story


In economics as in life, do not ask a question unless you know what you plan to do with the answer. This week, John applies this wisdom to measuring house prices.

House prices are rising in many countries. But by how much? British values go up and up, but there is wide disagreement about the extent. The Office of the Deputy Prime Minister claims that house prices have risen by 10 per cent in the past year. But the two leading mortgage banks, the Halifax and Nationwide, think the increase is more like 20 per cent. The Land Registry’s estimate is more or less halfway in between. The FT House Price Index, which draws on all these sources, puts the figure at 17.7 per cent.

The ODPM has the resources of the British government and its large staff of economists behind it. But people who are lending millions of pounds to homebuyers every day should know a thing or two about the housing market. And the Land Registry records every single transaction in the country. Who is right?

“What is happening to house prices?” appears to be a simple question. But it is not: every house is different. The simplest way to answer it – the one used by the Land Registry – is simply to take the average price of houses sold each month. But the result is dependent on the particular mix of properties that happens to come on the market. If Bernie Ecclestone, the Formula One promoter, completes the planned sale of his London house to Lakshmi Mittal, the Indian billionaire, for £70m, the average house price will rise, but will fall again the next month.

This measure will not even give an accurate picture of long-term trends, because some kinds of houses – mostly cheaper ones, such as starter homes for young couples – change hands much more often than others.

There are two different approaches to the problem. One is to take a representative selection of houses. You choose a mix of city-centre apartments, detached houses in leafy suburbs and terraced properties in grimy industrial cities. You calculate the monthly change in the hypothetical cost of buying this fixed collection of houses. This is the technique adopted by the ODPM.

The other approach uses a technique called hedonic pricing, which is currently fashionable among statisticians, if you can imagine such a thing as fashion among statisticians. Like an estate agent, the hedonist lists the characteristics that might attract you to a house – a prized location, a nice garden, an extra bedroom, proximity to public transport. Econometric analysis is then used to assess the value people attach to all those characteristics. When you have adjusted for the things that make some houses more sought after than others, you are left with an indicator of the price of housing itself.

What has been recently happening in Britain is that the price of shelter has been rising rapidly, but not the prices of the desirable attributes of a house. Why this should be so is not entirely clear, but the simplest and most likely explanation is that the continued housing boom forces people to economise on desirable attributes – they cannot afford to buy houses in the south-east of the country, they have to accept smaller gardens and less favourable locations.

The gap in price between more and less expensive houses, which widened in the early part of the housing price cycle, has therefore narrowed in its later phases. In the US, however, the house price boom is still concentrated in areas where houses are already expensive.

So whose measure of house price inflation is right? If you are a member of the Bank of England’s Monetary Policy Committee, and concerned that euphoria about rising house prices may leak into equity release – where people raise cash against the value of their homes – and consumer spending, the index from the ODPM is the one to watch. This measure tells you what is happening to the overall value of the national housing stock.

But if you just want to get a foot on the housing ladder, or are worried about the social implications of an environment in which young people have to struggle to find a place to live, it is the numbers posted by the mortgage banks that matter.

If you are a housebuilder with an eye on profitability, the appropriate measure depends whether you are simply building a roof over your customers’ heads or offering them all the attributes of a bijou residence. In economics as in life, do not ask a question unless you know what you plan to do with the answer.

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