Mixed signals being sent out in explosion of data tracking
ONE positive legacy of the property boom-and-bust is that we now have more data on Ireland's housing market than ever before.
The Residential Property Price Register has been a game-changer in providing transparent information on housing transactions at a local level. Likewise the Private Residential Tenancies Board (PRTB) index fills an important gap in our knowledge of Ireland's rapidly expanding rented sector.
But the biggest explosion of new data has come from the multitude of residential property price indices (RPPIs) that have emerged over the last decade.
While these indices are undoubtedly useful, their proliferation and the fact that they occasionally appear to send out mixed signals has the potential to cause puzzlement.
So let's cut through this confusion. How can sense be made of the different indices by both people in the industry and the man on the street?
In general, the aim of a price index is to compare the price of an identical basket of items over time. By ensuring absolute consistency in the basket of items between periods, this type of 'constant quality index' isolates the pure effect of market price changes.
If we deviate from this constant quality principle and allow the basket to contain a different mix of items in each period, we can no longer tell whether a price increase is due to an underlying change in market conditions or due to compositional change within the basket being tracked.
To illustrate: imagine that small apartments accounted for the bulk of property sales in one quarter. And in the subsequent quarter, by chance, large houses accounted for a much higher proportion of sales.
The result would be an increase in the average price of properties between the two quarters. However this does not reflect any underlying change in market conditions.
To combat these challenges, there are two broad approaches to achieving a constant quality RPPI.
The first and most straightforward approach is to identify a particular basket of housing units and to track repeated observations of their hypothetical value over time.
This is the methodology that several Irish estate agents use to compile their in-house residential price indices.
However there are practical drawbacks; firstly, because the estimated 'price' for each property in the basket is based on a valuer's appraisal, this inevitably involves some element of subjectivity.
Secondly, it is not clear that this methodology adequately accounts for depreciation on, and/or improvements to, the properties in question.
An alternative approach is to deploy actual price data, but control for differences in the mix of properties traded between periods using sophisticated econometric techniques.
This identifies a number of factors which are known to affect house prices – location, number of bedrooms etc.
The combined effect of these factors on price changes is then calculated and excluded. In principle, this leaves the element of price change that is solely attributable to underlying changes in the market.
Most of the mainstream RPPIs, both internationally and in Ireland, are based on variations of this method. This includes the benchmark CSO index, the old ESRI/PTSB index, and the indices produced by property portals Daft.ie and Myhome.ie.
This method has the advantage of being based on real price data. However, the complex methodology makes it something of a black-box to many users.
The old PTSB/ESRI index and the current CSO index are based on information provided by lending institutions about properties against which they have issued mortgages.
There are two practical consequences of this. Firstly, up to three months can elapse between a purchaser's offer being accepted (the point at which the price is set) and the mortgage being drawn down.
Therefore, in a rising market these indices may be expected to understate the extent of real-time price increases.
Secondly, in recent years there has been a strong upsurge in houses being bought entirely with cash. As such, the CSO index is currently missing a large chunk of marketplace activity.
Anecdotally, some agents believe that prices at this upper end of the market are also rising more quickly. If so, then the CSO index could potentially be understating price growth.
Because it does not keep a constant mix of properties between periods, the Residential Property Price Register cannot be considered a true price index.
Despite this, however, analysts may be tempted to derive average prices from the register and track these over time. Statisticians caution against this for two reasons.
Firstly, when there is a big shift in the mix of properties being traded, such an exercise can result in biased estimates of price growth.
Secondly, because there can also be purely random fluctuations in the mix of traded properties between time periods, a simple average price index is likely to prove inherently volatile.
Ireland's property crash led to a recognition that better data was needed for market analysis. A proliferation of new RPPIs arose from this realisation. While all of the indices add value to our understanding of the market, they differ in several important ways.
The first key message to emerge is that, in any given period, the idiosyncrasies of the individual indices can give rise to different signals about price growth.
Critically, however, these anomalies tend to iron themselves out over a longer period, and it is clear that all of the main mix-adjusted indices tell a broadly similar story over time.
Therefore a second finding is that the indices appear to give a reliable and consistent view of market trends over the longer run.
A third key conclusion is that caution should be exercised in deriving price indices from the Residential Property Price Register. Such indices tend to be inherently volatile. Moreover, when the mix of properties being traded in the market is shifting, they may also be significantly biased.
Having said that, the Residential Property Price Register has enormous potential to be developed further as a data resource.
With a new postcode system coming into place before the end of 2015, the register has potential to gather more granular information on housing transactions by location.
In addition, it could also be expanded to capture more detailed information on the characteristics of the properties being sold.
These developments would allow for a more sophisticated mix-adjusted index that would not only be based on a larger number of transactions, but would also incorporate both mortgage and cash-financed sales.
Dr John McCartney is Director of Research at Savills Ireland