How to Use a House Price Index

House price indices are popping up like For Sale boards on a show day. Most banks have one and more and more property analysts are developing their own indices to serve clients and investors. So what exactly is a house price index and what purpose does it serve for the average Joe who’s trying to determine whether he’s paying too much or has struck a bargain?

The purpose of a house price index is to measure house price inflation. But when you measure inflation you need to compare the same thing over time, and houses aren’t all alike, says property economist Erwin Rode of Rode & Associates.

The question is how robust is the index? A typical bank index is usually based on the number of bond applications received. A bank’s house price index might not be accurate if the bank’s market penetration is low. The “non-banking” indices are those developed by property economists and companies like Lightstone, which draw on Deeds Office data.

Rode says there is no perfect index just as there are no perfect statistics. All have their pros and cons. But an index is useful to track trends and estimate current value and it’s a broad indicator of what’s happening in the market, he says. Rode recommends using an index that hones in on cities and price categories. “If you want to estimate value in a particular area, it’s dangerous to use a national index.”

Doret Els, an economist from Efficient Group, says indices like those done by Lightstone are thorough. “Considering that they look at the Deeds Office data makes a difference. Banks won’t reflect un-bonded transactions.” That said, Els says there is generally not too much difference between Lightstone and the banks’ reports.

Els says that if she were looking to buy, the ABSA House Price Index would be the one she would look at because ABSA has historic data and the lion’s share of the market.

Don’t panic at the sight of a house price index, says Els. “It really shouldn’t intimidate home owners or prospective buyers. At the end of the day it’s really just like any piece of economic data – full of averages and trends. The most important thing is to use it as a benchmark when you’re looking at a house in a particular region. The house price index is not the gospel. There are many things that can influence your home’s value. For example, things like location and whether or not you have a good view can make your house price more resilient.”

Els says that one interesting thing that these reports do show is that the size of a home can be a major strength. “The price on smaller homes has proved to be more resilient.”

One rated tool for comparing house prices is the SA Property Transfer Guide or SAPTG, accessed via subscription on www.saptg.co.za

For the dummies among us, house price indices essentially compare two values where the difference is expressed as a percentage. An index is calculated over a fixed period. For example you compare the value of a house in January 2006 (say R1 million) with the value a year later (say R1,1 million). This indicates 10% growth. Over time this shows you a trend. Sometimes the trend in combination with other factors, like supply and demand, may convince you of what is going to happen in an area. If you want to predict how the market is going to behave you have to look at how it behaved when situations similar to the present happened in the past.

The brains at SAPTG explained that for home owners invested in their properties for the medium- to long-term, indices are not that important. For a buyer or a speculator with several properties in different areas, the index assists in making decisions. With every index consider the context in which it was done.

Let’s consider this example: Company “A” may for example only use a price bracket (say R750k to R1,5 million) to describe a “High Value Residential Property”. Company “B” may decide to use the same bracket, but further restrict it to sales between individuals only (excluding trusts, CCs, companies etc. because no “residential indicator” exists in the data). This can obviously result in different average prices for the same period in the same area.

All properties are unique and will therefore have a unique value. The value is only really determined when a property is sold. But, the circumstances of each sale could be different. A house might have been sold in a hurry because of a divorce, for example. If the buyer fell head over heels in love with the place then the price could be inflated. The more you know about individual properties in a specific area, the better your chances of being able to accurately determine value.