Few indices are watched more closely than those that track house prices. On one level that’s rational. Two thirds of households own their own home, most of them with a mortgage. Changes in house prices therefore have a huge impact on most people’s personal balance sheet – almost certainly a much greater impact than stock-market movements. But on another level, watching what is commonly thought of as ‘house prices’ is pretty irrational, because the indices are a fairly poor indicator of the value of your home.
There are many reasons why measures of house prices are flawed, but most are rooted in the truism that houses are unique. Their value is therefore much more subjective than the value of so-called ‘fungible’ (directly comparable) securities like shares or bonds. We can only be sure of a house’s value when it is actually sold.
Herein lies our first problem. All the UK house price indices are based on transaction data of one form or another, but houses are rarely traded. In the 1990s, the number of private dwellings sold only amounted to about 7 per cent of the housing stock, according to an enlightening paper on this subject by Gregory Thwaites and Rob Wood at the Bank of England.
Even indices that take account of all transaction data, like the one published by the consultancy Acadametrics, are therefore based on small samples relative to the total housing stock. And the other indices are based on small samples even relative to the 50,000 or so transactions that are currently being completed each month. Of course, small samples have the advantage of being quick to collect and process, so results can be published in time to be useful. But they may not be representative of the whole market, and results based on few data points can also be quite volatile.
A further problem is that even if all the houses on a certain street are sold in successive months, what does it actually tell us about 'house prices'? Perhaps one house had two bedrooms and another four; if one sold for twice the value of the other it does not follow that prices have doubled. Equally, comparing apparently identical houses across different areas does not work because location matters.
This sounds obvious, but it’s a headache for statisticians, who have to make so-called ‘mix adjustments’ or ‘hedonic regressions’ to arrive at an abstract 'average house' whose value their index tracks. Needless to say, these tweaks to the data can undermine their usefulness.
The only alternative is to track resale prices on houses that have already been sold. That is the approach taken by the Land Registry, but since houses are so irregularly traded, this involves ditching the majority of the data. And the same house may be in a very different condition from one decade to the next, so even resale values are not a watertight guide to house-price inflation.
Of course, these problems are immediately obvious to anyone who follows the indices, because they invariably contradict each other on a month by month basis, and often beyond. Take the best-known indices, produced by the mortgage providers. Nationwide found the price of a ‘typical home’ sold in the three months to March was 0.9 per cent lower than a year earlier, while Halifax found it was 2.9 per cent lower.
It was in response to a 6.4 percentage-point divergence between the Nationwide and Halifax indices that Mervyn King, then the Bank of England’s chief economist, called for greater clarity on house prices in a speech to the Building Societies Association in 1998. He attributed the divergence then to the lenders' different mix-adjustment techniques, but admitted this was only a “preferred explanation” of a phenomenon that remained “largely a mystery”.
A number of alternative indices have been set up since, in response to the strong housing market as much as to Mr King’s plea. They add to the picture, but also to the confusion. The best house-price watchers can do is simply to look at all the indices together whilst understanding what underpins them – I’ve summarised the key points in the table. At least the main indices do tend to agree on the direction and strength of the market, if not on its growth rate.
A final caveat, however: even if you understand these indices intimately, you will not be much the wiser about the value of your own home. That’s because housing is a local market, and although most indices split prices down by region, and some by County Council or London Borough, even the most granular subdivisions include many postcodes with distinct characters and housing markets. “There’s an overriding issue of generality,” complains Neil Young of the Young Group, a South London landlord and property-management firm.
This problem has been alleviated by the advent of internet-based search engines like Zoopla, which publish the Land Registry’s data on sold house prices. It is now very easy to find out what houses on your street have fetched on the market, albeit about three months after completion. If you know the houses in question, this can be a useful guide. But remember, the only sure way to find out what your house is worth is to sell it.
