A dependable and accurate house price index is an important tool. High changes in house prices (either up or down) can have a significant impact on consumers, businesses and government. As sales volumes in many areas in Australia fall, the sample sizes used to calculate median prices is reduced.

In most markets, house prices are skewed. The mean is often much further out in a long tail than is the median. There are often many moderately priced houses and very few expensive mansions. The few expensive houses pull the mean up but generally will not affect the median.

One of the key problems with using the median price is the heterogeneous nature of housing markets. If we try and collect a larger sample by expanding our radius too far, we may collect prices from vastly different markets or sub-markets. It is important to look at the area that the median represents (e.g. suburb level) as well as the total number of sales used to collect the figures.

The Repeat Sales Method is widely used around the world. It only looks at properties that have sold twice, which helps control for the differences in housing stocks. It looks at price changes rather than prices themselves and is generally accepted as least effected by reductions in sample sizes.

Hedonic regression methods are also used, which leverage the quantitative characteristics of properties sold. Property sales must have accurate attributes to enter the model and as with the median method, can be subject to problems if sample sizes are too small.

These models do not adequately control for the actual quality differences between properties. If all of the houses sold have been renovated and no expense spared, this can artificially inflate the index result. However a simple and easy to use solution is available - Retrospective Valuations.

The Retrospective Valuation Method (RVM) uses two valuations of the same property, adjusted for quality in both periods. In simple terms, you take a house and value it now, then revalue it an earlier date. For the method to work, a solution must be used that allows for quality adjustments between the comparable sales and for retrospective dates.

For home-owners, lenders or real-estate professionals, this method allows a sub-market to be better analysed. For example, if the subject property is recently renovated, it can be valued as a renovated property in the second period and un-renovated in the first period, controlling fully for changes in quality. Try it for yourself on your own home today.

To see an example of the Retrospective Valuation Method, click here

Article courtesy of Kent Lardner