D-4 / HCPI 07/585
Luxembourg, September 2007
Working Group
"Harmonization of Consumer Price Indices"
to be held in Luxembourg
Tuesday and Wednesday 23-24 October 2007
at 9h30, room M2, JMOBuilding
Item 5 of the Agenda
Owner-Occupied Housing
- Draft OOH Technical manual -
The WG is invited to take note of the progress made and give their opinion on the current version of the manual.
Paper by Eurostat
Owner-Occupied Housing
– Draft OOH Technical manual
In conjunction with the second phase of the Owner-Occupied Housing price indices pilot Eurostat commissioned INE Portugal to update the draft OOH manual (Manual on Owner Occupied Housing - Draft Technical Manual, version 1.00).
The objective of Manual update is to develop further the methodology described in the first version of the draft OOH manual and produce an operational handbook for HICP practitioners.The OOH manual should cover all areas of the needed elements of OOH indices, such as price indices for new and second-hand dwellings, indices for renovations and major repairs, changes in land prices, as well as price indices linked to additional acquisition costs, and also explain all important aspects of OOH index compilation, e.g. data collection, quality adjustment issues, such as hedonics, stratification, repeated sales method, Sales Price Appraisal Ratio Method, and weights (e.g. sources and problems in the compilation of weights).
The updating projectby INE started in September 2006 and was scheduled to have following milestones:
–September 2007: The first updated version of Technical Manual
–January 2008: The second and improved version of the Technical Manual
–February 2008: The final version of the updated manual.
The attached Manual version 1.3 represents the situation in September and it is thus expected that there will be one interim version more before the final updated manual at the end of February 2008.
The Manual at hand is work in progress and it is important to note that the version is therefore a provisional one and that more improvements are going to be included in the next few months. In order to make the Manual as good as possible Eurostat would appreciate the WG feedback on it.
Eventual comments can be sent to via email to
and
The Working Group is invited to
-take note on the progress
-comment on the structure and content of the current version of the manual
-give advice to Eurostat on directions to further improve the manual.
TECHNICAL MANUAL
on
Owner Occupied Housing
Harmonised Index of Consumer Prices
draft version 1.3
August 2007
Draft version1
Contents
On this version of the manual......
1.Owner-occupied housing as a part of a consumer price index......
1.1.Owner-occupied Housing as a measurement issue......
1.1.1.The nature of the problem......
1.1.2.National Accounts perspective......
1.2.Approaches to the measurement of Owner-occupied Housing......
1.2.1.Acquisitions......
1.2.2.Use......
1.2.3.Payments......
1.2.4.Exclusion of Owner-occupied Housing......
1.3.Relationship between CPI purpose and the choice of the OOH approach......
1.3.1.Different purposes, different approaches......
1.3.2.Non-comparability of results......
1.3.3.The Harmonised Index of Consumer Prices......
1.3.4.Empirical evidence on the application of different approaches in the HICP......
2.The Net Acquisitions approach......
2.1.The “net” concept
2.2.Treatment of second-hand dwellings
2.3.The treatment of land
2.4.Some issues regarding the implementation of the approach......
2.4.1.Definition of new and second-hand dwellings......
2.4.2.The issue of timing......
2.4.3.Expenditure versus stock weights......
2.4.4.Extension of HICP coverage......
2.4.5.Borderline cases between rental and Owner-occupied housing......
2.5.Volatility and comparability issues in the construction of new dwellings indexes......
3.System of house price indexes......
3.1.User needs, aim and design of the system......
3.2.Difference between traditional price index solutions......
3.3.HICP requirements......
3.4.Data requirements......
3.4.1.Quality of index weights......
3.5.Stand-alone House Price Index......
3.6.Price indexes for new dwellings (OOH/HICP index)......
3.6.1.Price index of newly built dwellings......
3.6.1.1.Purchase of new dwellings from estate agents and construction companies......
3.6.1.2.The data sources - summary......
3.6.2.Self builders......
3.6.2.1.Three main types of self builders......
3.6.2.2.Note about "Cost index" and "Price index"......
3.6.2.3.The Regulation for Short Term Statistics (STS-R)......
3.6.2.4.Data sources and construction of indexes for self-builders......
3.6.3.Second-hand dwellings new to the household sector......
3.6.4.Aggregating the OOH/HICP index......
3.7.Indexes for the purchase of second-hand dwellings......
3.7.1.Second-hand dwellings and transaction costs......
3.8.Renovations and repairs price index......
3.9.General compilation principles......
4.Quality adjustment......
4.1.Possible ways of tackling the issue of quality change......
4.2.Hedonic regressions and price indices......
4.2.1.Time dummy variable......
4.2.2.Characteristics price method......
4.2.3.Single and double imputation......
4.2.4.The constant prices method......
4.2.5.Practical issues......
4.2.5.1.Number of observations......
4.2.5.2.Key variables......
4.2.5.3.The issue of weights in regressions......
4.3.The SPAR method......
4.4.Examples on the calculation of the price index of newly built dwellings......
4.4.1.1.A numeric example on calculation and application of a regression model......
5.Land price index and other relevant issues......
5.1.Land indices......
5.1.1.Specific price index for land......
5.1.2.Econometric modelling......
5.2.Sampling, stratification and product coverage......
5.3.Insurance connected with the dwelling......
5.4.Evaluation of the system of price indexes......
5.4.1.Eurostat’s quality dimensions......
5.4.2.The A/B/C methodology......
6.Empirical examples......
7.Glossary of main terms......
List of Tables
Table 1: Relationship between the choice of the OOH approach and CPI purposes
Table 2: An example of non-comparability of CPI results
Table 3: Percentage of households in own-occupied dwellings (2002)
Table 4 Impact of OOH on the HICP (Annual data, Euro-zone, 1996-2002)
Table 5: Definition of the HICP/OOH scope (“new” versus “second-hand” dwellings)
Table 6: Proposal for a classification system for the system of price indexes related to dwelling ownership (based on present HICP/COICOP classification)
Table 7: Expenditure shares for house ownership components in the Australian and New Zealand CPIs
List of Figures
Figure 1: The payment, acquisition and use moments when buying a house
Figure 2: dwelling ownership flows between and within sectors
Figure 3: Input- and Output-indices
Draft version1
On this version of the manual
The present draft of the future Technical Manual on Owner Occupied Housing[1] intends to provide guidelines for the development of a system of price indices associated with the purchase or improvement ofdwellings for own use in the context of the Harmonised Index of Consumer Prices (HICP).
When reading this manual, it should be kept in mind that the conceptual measurement construct underlying the inclusion of Owner Occupied Housing into the HICP context is based on the Net Acquisitions approach and not on the Use or Payments approaches.
Under the followed approach, prices are measured to reflect the change in the acquisition cost of the goods and services which are new to the household sector as a whole and not as, for instance, the change in the cost of the goods and services which are actually consumed by households.
The development of the manual follows two interrelated topics. The first one focuses on the Net Acquisitions approach as the main conceptual measurement construct for the building of the system of price indices on Owned-occupied Housing in the HICP context. Readers wanting to know more about what it is meant to be measured should refer to the first two sections of the manual. The second topic deals with index building issues. The bulk of the manual deals with this topic. The manual presents, whenever it is possible, empirical examples. A glossary of main terms is presented at the end of this manual.
Although this manual is primarily targeted to help national statistical offices to build a system of price indices associated with the acquisitionor improvement ofdwellings for own use, it may equally benefit all users who wish to learn more on this particular inflation measurement aspect.
This draft rests upon an earlier version of the manual (Eurostat, 200x) and on the solutions, experiences and problems that have been put forward by several European statistical offices participating in Owner-occupied Housing pilot work programmes since 2001[2].
As pilot work is still under progress, this manual should be regarded as provisional and subject to changes. Comments on this version are, for this reason, welcome.
1.Owner-occupied housing as a part of a consumer price index
1.1.Owner-occupied Housing as a measurement issue
1.1.1.The nature of the problem
Difficulties revolving around the inclusion of the Owner-occupied Housing (OOH) component into a consumer price index (CPI) are inextricably linked to the characteristics of the good at stake. Housing is a major durable, acquired at a certain point of time, used throughout many years and whose purchase is, in many situations, financed by means of credit.
The separation between the moment of payment, acquisition and use of housing is what, in reality, poses the first measurement problem to CPI compilers. In presence of these temporal differences, when should the value of a house be recorded?
Figure 1: The payment, acquisition and use moments when buying a house
Moreover, durability of housing implies that a flow of services will be provided to own-occupiers after its acquisition[3]. As these services are output produced by own-occupiers for their own consumption, no market value exist and a second possible measurement problem appears. On what basis is the value of the services, if any, going to be estimated? What approach would have to be followed?
These questions will be addressed in the next sections. At this stage, it suffices to say that no “perfect” solution exists for the inclusion of OOH into a CPI and that the answers to the questions mentioned above would ultimately depend on the purpose of the index.
1.1.2.National Accounts perspective
In the United Nations System of National Accounts (SNA93) and in the European System of National Accounts (ESA95), when a durable good (other than housing) is purchased by a consumer, all of the expenditure is attributed to the period of purchase even though the use of the good extends beyond the period of purchase.
Housing, however, is treated in a rather different way than other durable goods. One of the reasons for this position is rooted in the idea that, as the benefits of using a house normally extends over many more years than in comparison with other durables, it is somewhat unreasonable to charge its entire purchase cost to the initial period of purchase. If this point of view is followed, then there is the need to distribute the initial purchase cost over the useful life of the asset and make use of some sort of value imputation in a CPI.
This issue is tackled in the SNA93 and in the ESA95 by clearly separating acquisition from use, the former being valued as investment made by households and the latter as consumption of housing services made by own-occupiers. More specifically, the SNA93 and ESA95 perspective on this issue considers:
the benefits of using a house as services of owned-occupied dwellings which are consumed by the household to which the owner belongs;
the imputed values regarding the flow of benefits steaming from the use of the house as final consumption expenditures of the owners;
that the imputed value of the housing services provided to own-occupiers could be estimated on the basis of the rentals that would be paid on the market for accommodation of the same size, quality and type;
the acquisitions of dwellings or residential structures for own use as gross fixed capital formation[4];
- that the dwellings are valued in the capital formation account on the basis of their acquisition value.
From a pure National Accounts view, the inclusion of the OOH in a price index not exceeding the boundaries of consumption is only attainable from a use perspective. According to this framework, dwellings are catalogued as fixed assets and, as a result, its acquisition price should not be included in a price index attempting to measure consumption.
In light of this, the measurement of OOH in a CPI would ultimately imply the acceptance of non-monetary imputed values for the estimation of the worth of a service for which there is no market price.
At this stage of the manual, the reader should bear in mind that this is essentially valid in a context in which the dominant purpose of CPI is to supply National Accounts with an indicator which is totally consistent with its conceptual framework. As it is going to be described below, this is by no means the only possible purpose of a CPI. National Accounts constitute, nevertheless, a good basis for the mapping and evaluation of the different approaches to OOH.
1.2.Approaches to the measurement of Owner-occupied Housing
The literature dealing with CPI compilation issues usually points out the Acquisitions, Use and Payments approaches as the three main conceptual frameworks to include OOH in a price index[5].
Apart from these approaches, it is possible to argue that excluding OOH from the CPI constitutes, in itself, a fourth (and somewhat overlooked) solution to this issue. The following sections provide a brief explanation on each one of these possible ways of dealing with OOH.
1.2.1.Acquisitions
Under the Acquisitions approach, prices are recorded at full market price, ignoring the problem of distributing the initial cost of the durable over the useful life of the good. The total value of the acquisition is thus entirely allocated to the period of purchase, regardless of when its consumption starts and how its payment is carried out.
A possible system of price indices based on this approach would include the following information:
- Expenditures on new and second-hand dwellings;
Local authority and other fees related with purchase or construction;
Repairs and maintenance; and
- Insurance connected with dwellings.
One of the advantages of this approach is that treats all durables in the same manner and that no special procedures have to be developed by a statistical agency to deal with this issue.
A possible disadvantage of the application of this approach is that if the base year corresponds to a boom year (or a slump year) for the durable, then the base period expenditure weights may be too large or too small. Put another way, the aggregate expenditures that correspond to the acquisitions approach are likely to be more volatile than the expenditures for the aggregate that are implied by other approaches. However, this problem can be minimised if, for instance, an average of several years are taken into account.
The application of this approach usually takes the net form[6]. The net principle means that only transactions between the household sector (which is the target population of the index) and other sectors are considered. This approach will be presented in more detail in section 2 of this manual.
The net acquisitions approach does not imply the use of imputed prices and is more in accordance with the definition of an inflation index.
1.2.2.Use
The Use (or consumption) approach is closely related to modern microeconomic theory and to the cost-of-living price index theoretical framework. Underlying this approach is the idea that the (economic) value of a house is based on the benefits that are extracted from using an own house which are, in turn, equal to the opportunity cost of the best alternative use to the consumption of that same housing services. As there are two basic alternative uses, there are, as such, two basic approaches.
Roughly speaking, the first alternative use basically consists in investing the value of the dwelling in the best alternative use available on the market. More specifically, in this approach, the initial purchase cost of the durable is decomposed into two parts: one part which reflects an estimated cost of using the services of the durable for the period and another part, which is regarded as an investment, which must earn some exogenous rate of return. In theory, a system based on this approach (known as the User Cost approach) would have to include information on the following variables[7]:
- Repairs and maintenance;
- Insurance;
- Local authority and other fees related with purchase or construction;
- Mortgage interest;
- Depreciation of dwellings; and
- Opportunity cost of alternative investments.
The second alternative is to lend the dwelling to a tenant. This approach is known as the rental equivalent approach.
In the rental equivalence (or leasing equivalence) approach, a period price is imputed for the durable which is equal to the rental price or leasing price of an equivalent consumer durable for the same period of time[8].
The rental equivalence approach is the only that does not require the compilation of an index on repairs and maintenance. The reason for this is because it is reasonable to assume that the repairs and maintenance costs, which are normally assumed by landlords, are reflected in the rentals paid by tenants. The major drawback of this approach is that its applicability is somewhat misleading in situations were the rental market has not a big expression or/and is heavily regulated.
Weights of the use approach tend to be higher than the ones that are derived from the acquisitions approach because capital costs are excluded in the net acquisitions approach whereas they are explicitly or implicitly included in the variants of the user approach.
The inclusion of capital costs into weights, together with the use of imputations, may be hard to explain to users. These can be seen as two factors with a potential to undermine CPI credibility.
1.2.3.Payments
Under this approach, what is measured is the change in money outlays made by households in relation to housing goods and services. Expenditure is defined in relation to all payments for those goods and services, regardless of when they were actually consumed or acquired[9].
In principle, this variant does not require imputed or theoretical prices. A system of price indices based on this approach could include the following items:
- Cash spent on the total or partial purchase of dwellings;
- Local authority and other fees related with purchase or construction;
- Insurance connected with dwellings;
- Payments on repairs and maintenance; and
- Mortgage interest payments.
The main drawback associated with this approach has to do with the inclusion of mortgage interest payments. This means that the CPI would be subject to the influence of changes in the interest rates. This characteristic may be undesired, especially in a CPI which is, as it is the HICP, used for inflation monitoring purposes.