A new way to bet the house

Property Observer

Rismark and RP Data, in conjunction with the Australian Stock Exchange, have today launched a new ‘daily' house price index suite. This will cover all the major cities and the national market, and will be quoted by the ASX as a precursor to the development of exchange-traded products, such as house price index-linked futures.

The new indices track the change in the value of the overall asset class (known as the stock) rather than simply being limited to the 5-6 per cent of all homes that transact each year (called the flow).

Based on their new daily hedonic home value index, RP Data-Rismark report that dwelling values across Australia's eight capital cities rose 0.8 per cent in the month of February, although due to a slump in the seasonally-slow month of January year-to-date dwelling values are still soft-to-sideways (-0.2 per cent).

Encouragingly, in the month of February, dwelling values rose 0.8 per cent in Sydney, 1.8 per cent in Melbourne, 1.0 per cent in Adelaide, 2.2 per cent in Hobart, 5.0 per cent in Darwin, and 1.9 per cent in Canberra. The only cities to record falls in home values in February were Brisbane (-0.1 per cent) and Perth (-1.8 per cent).

These ASX-quoted daily house price index products should improve the accuracy and timeliness of the information available on Australia's largest investment class, residential housing, which is valued at $4 trillion in total. They will also offer us the first historical insights into what happens to house prices on an ‘intra-month' basis.

Analysts in this area will recall that most house price indices currently report on a ‘quarterly' frequency. Rismark and RP Data started publishing a low volatility monthly ‘hedonic' house price index back in 2006.

But the notion of accurately tracking daily movements in Australia's most talked-about asset class is a potential game-changer. As the first chart below shows, the new daily index moves in a generally similar fashion to the old monthly version when calculated over the long-run (in this case since 1995).




However, on an ‘intra-month' basis the daily index opens up fluctuations in house prices that frankly nobody has ever been exposed to before. This is highlighted by the second chart below, which compares the daily index with its monthly predecessor, but this time sampling daily and monthly, respectively. Observe how the monthly index looks like a smoothed version of the daily one.




Throughout history researchers have been restricted to ‘low-frequency' house price proxies that look like the red line in the above chart. Around the world, house prices are typically reported with a one month to four month lag. Even in Australia, RP Data-Rismark's old benchmark was reported with a one month lag while the ABS publishes on a quarterly basis one month after the end of the quarter.

In the future, we will get daily updates on movements in Australian home values. Will this open us up to the wild swings associated with the sharemarket? The short answer is: no.

In the final chart I've compared daily changes in the S&P/ASX 200 sharemarket index with RP Data-Rismark's new benchmark. This puts into striking perspective questions about the volatility of the new daily measure, which, as you can see, is substantially less variable than its listed equity equivalent.




The differences in the chart above accord with what we understand about housing as an asset class more broadly: once you diversify at the national ‘index' level, volatility is very low and a fraction of the riskiness of equities. Of course, it's not very easy to invest in a house price index. That is precisely why the ASX has got involved.

The ASX's product development manager, Brian Goodman, says the exchange is investigating "the creation of exchange-traded products with the objective of allowing investors to replicate the performance characteristics of Australian residential property. The ability to obtain and optimise residential property exposures with an exchange-traded product will enable investors to efficiently manage exposure to this asset class”.

One obvious question is: how did they do it? The technology underlying the new daily index is sophisticated, and, if you are really interested, you can read three different papers on it here.

The daily index leverages off the fact that in Australia all home sales are collected and reported by valuer general's offices – ie, we don't have ‘small sample' biases like the US or UK – and RP Data's enormous financial investment in extra data-gathering.

The simplest explanation as to how the index works is this. First, RP Data has very detailed information on 99 per cent of all Australian homes, including the exact address, land size, property type, historical sales prices paid for the property, its distance to the local GPO, listing information for the home and like dwellings in the area, its number of bedrooms, bathrooms, and car spaces, and whether the property has things like a pool or a tennis court. In addition to this information, RP Data captures, on average, around 1,400 new home sales every day.

For the purposes of the daily index, RP Data and Rismark have taken a portfolio of around five million capital city homes across Australia, and all of the specific attribute information that pertains to them, and used the flow of incoming sales data to re-price the portfolio.

This is similar to the way most financial market indices work. Consider the ASX's All Ordinaries Accumulation Index. This includes every company listed on the ASX. Each company has a weighted contribution to the index. As new sales data is received, the company's price is updated, and the index changes accordingly.

Researchers will want to ask obvious questions, like: how do the returns differ over time between the two methods; is the new index more volatile than the daily index; and why don't you seasonally adjust the ASX indices?

Analysis of the new and old indices shows that both their monthly volatility and average annual returns are very similar (eg, over the last few years, monthly volatility for the daily index has been 0.84 per cent while the old index's volatility was 0.83 per cent).

This is important. As the first chart above shows, the daily index does not tell us anything especially new about the low-frequency direction of Australian home values over the last 15 years.
It will, however, give us important new insights into weekly, fortnightly and monthly changes in national home values on a daily, rather than a one month lagged, basis.

On the question of seasonal-adjustment, RP Data and Rismark are currently undertaking a detailed review of the methods they use for controlling for seasonality in house price movements. Upon completion of the review, they will commence publishing a seasonally-adjusted ‘analytical series', much like the ABS does with its inflation data.

However, as is the case with financial contracts traded on inflation (or any other asset for that matter), the ‘tradeable' index will track actual or ‘true' changes in home values, rather than a statistically smoothed series.

Christopher Joye is a leading financial economist who serves as a director of Yellow Brick Road Funds Management and Rismark International. Christopher was actively involved in the development of the daily indices during his time as an executive of Rismark, which he is still a director of.

This is an edited version of an article which first appeared on Property Observer on March 1. Republished with permission.