What it means
The problem an index solves is that no two houses are identical. If the average sale price rises 8% in a quarter, that may mean prices rose, or it may just mean more large houses happened to sell.
A well-built index controls for the mix so that the movement it reports is closer to a genuine like-for-like change. There are two main construction methods.
A repeat-sales index compares the prices of the same properties when they sell more than once, which naturally controls for quality but ignores homes that rarely change hands. A hedonic index instead adjusts statistically for characteristics such as floor area, bedrooms and location, which uses more of the data but depends on the model being right.
Indices also differ by the point in the transaction they measure. Some use mortgage approvals, some use asking prices, some use completed sales registered with a land registry, and each lags the market by a different amount.
Asking-price measures move first and are the noisiest, while registered-sale measures are the most reliable and the slowest, sometimes by several months. Businesses use these indices in concrete ways.
Lenders revalue mortgage books and calculate loan-to-value ratios by indexing old valuations forward, insurers use them in rebuilding and reinstatement models, and property developers use regional series to decide where to build. Governments use them for policy, taxation and, in some countries, for indexation of certain payments.
The important caution is geography. A national index can rise while your specific city falls, because housing markets are highly local, so the right question is always which index, covering which area, measured at which stage of the transaction.
Using the wrong series is the most common way these numbers get misapplied.
In practice
Real-world examples.
Example
A building society revalues its mortgage book each quarter by applying regional house price index movements to the original valuations. The exercise updates loan-to-value bands and feeds directly into how much capital the society must hold.
Example
A housebuilder deciding between two sites compares five-year index growth for each local authority area rather than the national figure. One area has grown 31% and the other 9%, which changes the expected sale prices in its appraisal.
Example
A council assessing an affordable housing scheme uses an index to convert historic scheme costs into current-day terms. Without the adjustment, a comparison against a scheme built six years ago would understate today's cost by a wide margin.
Formula
Calculation
Index level = (Current period price measure / Base period price measure) x 100, and Period change = (Current index - Prior index) / Prior index
Assume an index is set to 100 in its base year of 2015 and currently stands at 168.0. That means representative prices in the covered area are 68% higher than in the base year. A house that sold for $320,000 in 2015 has an indexed value of $320,000 x 1.68 = $537,600, which is an estimate of what a similar property would fetch now, not a valuation of that specific house.
Now look at the annual movement. If the index stood at 160.0 twelve months ago and 168.0 today, the annual change is (168.0 - 160.0) / 160.0 = 5%. A lender holding a mortgage of $250,000 against that indexed $537,600 property would calculate a loan-to-value ratio of $250,000 / $537,600 = 46.5%, down from $250,000 / $512,000 = 48.8% a year earlier when the indexed value was $320,000 x 1.60 = $512,000.Case study
Seen in the real world.
This illustrative case features a fictional lender, Marchbank Building Society, which had been reporting the average loan-to-value across its book using original valuations from the date each loan was written. Some of those valuations were nine years old.
A new risk director pointed out that the reported figure was neither the current risk nor a useful trend. The society moved to indexing every valuation forward using a regional house price index, splitting its book across seven regions rather than applying one national series. The reported average loan-to-value fell from 71% to 58%, but more importantly the distribution changed: one region showed a cluster of loans above 90% that the national figure had completely masked.
The illustrative point is that an index is only as useful as the granularity it is applied at. Marchbank did not change a single loan, yet its picture of its own risk improved substantially simply by using the right series at the right geographic level.
Watch out
Common mistakes.
- Reading an index level such as 168 as a price in dollars, when it is a ratio to the base period and carries no currency meaning on its own.
- Applying a national index to a single property or a single town, which can be badly wrong because housing markets vary enormously by area.
- Comparing two indices directly without checking that they share a base year, a construction method and the same stage of the transaction.
Questions
People also ask.
What does a base of 100 mean?
It means the index was set to 100 in a chosen reference period, so a reading of 168 indicates prices are 68% above that reference level.
Which index is most accurate?
Repeat-sales indices based on registered transactions are usually the most reliable for measuring genuine price change, but they lag the market, so faster asking-price measures are often used alongside them.
Can an index value my house?
No, it estimates how a representative property in an area has moved, so it can index a past valuation forward but it cannot replace a surveyor's assessment of a specific property.
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