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The Best Home Price Index

According to the latest quarterly report from the Office of Federal Housing Enterprise Oversight (OFHEO), home prices increased in the three month period ending on June 30. The OFHEO House Price Index (HPI) rose 0.1% when compared to the first quarter of 2007 and 3.2% when compared to the second quarter of 2006. The OFHEO Purchase-Only Index, which excludes refinancings, rose 0.5% from the previous quarter and only 2.6% higher year-over-year. Other reports from the National Association of Realtors and the Case-Shiller Home Price Index have shown price declines and predicted future home price declines. The OFHEO index has never been negative on a year-over-year basis.

Back on February 7, O. Emre Ergungor, an economist at the Federal Reserve Bank of Cleveland, compared the three home price indices and published his findings on the bank’s website. According to Ergungor:

Despite their potential weaknesses, the Case–Shiller Indices are still an improvement over other house price indices commonly cited in the media, one published by the Office of Federal Housing Enterprise Oversight (OFHEO) and another by the National Association of Realtors (NAR). (Freddie Mac also has an index that is very similar to the one published by OFHEO.)

He goes on to explain the differences between the 3 indices:

The Case–Shiller, OFHEO, and NAR indices differ in fundamental ways. The NAR Index does not use a repeat sales methodology but tracks existing homes’ median value—the value at which half of the home values in an area are worth more and half are worth less. But the median can easily be biased by new housing construction in an area. New homes for high-income people will pull the median up, while new homes for low-income people will push it down.

As a result, the index will capture changes in the median price that are related not to changes in home values but to changes in the composition of the housing stock. The OFHEO Index resembles the Case–Shiller Indices in that it utilizes the repeat sales methodology; that is, it tracks the value of individual homes that are resold over time. Its weakness is that it is based solely on houses whose mortgages are purchased by Fannie Mae and Freddie Mac. This prevents the index from representing the entire housing stock of the community. For example, the mortgage of the house that is being followed must be less than Fannie and Freddie’s conforming loan limit—$417,000 for a single-family home in 2006. To put this limit into perspective, note that the median home price in New York City is around $450,000. With 10 percent down, the median house would require a $405,000 mortgage. So the OFHEO Index for New York City could conceivably ignore almost half the housing units in the area. An even larger share of housing units would be left out of the calculations in San Francisco, where the median price is about $750,000.

On August 28, the latest Case-Shiller U.S. National Home Price Index showed U.S. home prices had suffered their worst decline since the creation of the index 20 years ago, according to a report compiled by Standard and Poor’s and economist Robert Shiller. Prices were down 3.2% in the second quarter compared with the same period in 2006. Shiller, the creator of the index and chief economist at New-Jersey based MacroMarkets LLC, added, “The pullback in the U.S. residential real estate market is showing no signs of slowing down.”