Owner Occupied Housing: Market Price Approach to User Cost

1. Owner Occupied Housing: Market Price Approach to User Cost Rósmundur Guðnason, Statistics Iceland Joint UNECE/ILO Meeting on Consumer Price Indicies Geneva, 4-5 December 2003

2. Market price approach; weights • Housing weights in the index can be decided by different methods • simple user cost where the real interest and depreciation is approximately fixed • rental eqivalence, Nacc data or ask consumers about rent • net aqusition, by capitalizing durables • These are different methods to decide the share of housing expenditures in the index

3. Market price approach; price measurement • Using market price change when measuring housing inflation • Simple user cost, price change in the market prices of all properties sold, old and new • Rental equivalence, using market rent to change prices of OOH • Net aqusition, market prices of new houses • All three similar: independent of the method used in the aggregation of weights

4. Owner Occupied Housing: Simple user cost • Simple user cost: (real interest+depreciation)Xproperty value • Calculated as a present value of an annuity, as repayment for loan • The annuity, covering both depreciation and interest, rent is the same over the lifecycle of the durable • Land Registry calculates the real estate value of a property in harmonised way • Both interest and depreciation calculated from this property value base

5. User Cost: Real interest rate, definition • Fishers (1896) identity; Nominal interest=Real interest rate X Inflation (CPI) • Real rate=Nominal rate/Inflation (CPI) • Iceland, long time real interest rate are preset, indexed with the CPI

6. User Cost: Real interest rate, calculation • Long term real interest rate • return on investment over the lifetime of the durable • capital gain measured as the real interest rate • The average real interest rate combines ex ante • own equity, fixed real interest rate • mortage real interst rate, variable rate • result the opportunity cost over the lifetime of the durable

7. User Cost: Real interest rate, estimation • Weight share estimated mainly from sales contracts • Own equity rate • fixed over the durables life • estimated with the same rate of return as pensions funds • the real interest rate is 3 per cent per year • Other long term rates • variable over the durables life • estimated same as the average real interest for loans in the sales contracts • the other real interest rates lie in the range of 5 to 9 per cent per year

8. User Cost: Real interest rate, results • The average real interest rate • approximately 4 per cent since 1992 • stable over the period • The interest rate, direct influence on the annuity • Changes in the real intrest rate, direct influence on the property sale cash price • Result, user cost unchanged or lower

9. User Cost: Depreciation • Estimated, lifetime of the property, division after age of the stock • House depreciation rate, 1.5 per cent, 1/ 0,015 = 67 year • Land no depreciation • Calculated as a average rate for both, 1.25 per cent, 1/0,0125 = 80 year • Depreciation is geometric with following caracterristics • inverse geometric rate, it is low in the beginning, high in the end • the durable depreciates fully, like one hoss shay

10. House price index: Property prices • Sale contracts are collected by the Land Registry • from the Registry of Deeds • Standardised, detail about • the property • form of payment • Sale contracts are used • Land Registy, real estate value with hedonics used in the calculation of the user cost • Statistics Iceland, price change of properties of the user cost

11. House price index: Cash price • CPI price concept: cash prices • Method of payment decisive in the case of housing • Necessary to calculate the present value of the sale contracts • Five different forms of payment • Money, often paid over a year, Housing Bonds, other durables, new Housing Bonds, overtaken loans

12. House price index: The present value of a contract • Discounted by the type of payment • Discounting of Housing Bonds weight heavy and over a shorter period of time the nominal price can deviate from the cash price • The effect of change in discounting of Housing Bonds • lower rate used, higher present value: lower mortage rate; higher house prices • higher rate used, lower present value: higher mortage rate; lower house prices

13. House price index: Calculation • Present value of the property from the sale contracts • Detail of the index • Average present value of a sale contracts per square meter • Weight, three years average of sold properties bye size, fixed • Time period; moving three month average • Type of housing; four types • Size; five groups for each type, kept constant over a longer time period, quality adjustment • Main indices; four

14. Summary • The most important aspect of OOH question is the use of market prices in the price measurement • Three main methods are used for deciding weights • Simple user cost method uses a real interest rate approximately fixed and depreciation for deciding the expenditure share • The price change of properties is measured by a constant quality price index for all properties sold