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House Prices [Apr. 14th, 2004|07:35 pm]
I think the headline figures on house price inflation are exaggerating how high it is. This is rather important given that it's the main reason the Bank of England are likely to keep increasing interest rates - damaging other areas of the economy such as manufacturing and exchange-rate sensitive exporters. It just came to me today why, so I thought I'd set it down before I forget.

We know that there is some extra inflation factored in by the fact that a lot of people have been using extra cash from their mortgages since prices went up a bit to do their homes up, so we're not comparing like for like - the quality of houses has increased over the last few years, so the price logically will, a lot of people have also been buying cheap houses and doing them up.

That's not what's occurred to me though, I already had an idea of that. My concern is about velocity. A lot of the house price indices work out average prices in a very simple way. They add up all the sales, and divide by the number. An average. However, that's the average price of houses which are actually sold, not the price the average house would cost if it were sold.

What's the difference, you ask? A lot has been made in the media of the fact that first-time buyers are being priced out of the market, and indeed a smaller number of sales are to people buying there home for the first time than ever before. What does that actually mean? It means that a larger percentage of the market is made up of people moving from one house to another. Higher velocity at the top end of the market. This skews the average.

If flats cost 3x and houses cost 7x, then if 100 people buy flats and 100 buy houses, the 'average price' of a home is 5x, but if 50 people buy flats and 150 buy houses, the 'average price' of a home is 6x - without house prices changing at all, the 'average price' has gone up by 20%! This might be why the Office of the Deputy Prime Minister, which actually has some like-for-like data, is not recording such outlandish price rises.

The question is, what does this mean if prices start falling - if first time buyers come back into the market, then prices at the lower end of the scale will actually hold up, yet any increase in affordability for them will make it appear that the market is collapsing, and create a panic in which they actually do fall, especially as possible negative equity issues prevented existing home-owners from moving.