An index that runs rings around others

 

Efforts to cool the housing market are hampered by some questionable statistics

 

One of the most widely used housing indices in China is the China 100 city housing index compiled by China Index Research Academy. According to the index's website, it is based on project housing now on sale, and the weighting of each project is the sales, in transaction value, of each housing project. 

 

The scholars Robert Shiller and Karl Case raised questions about a method based on new on-sale projects, and they were so uncomfortable with such an approach that they came up with a housing index based on repeat sales of existing houses/apartments. The Case-Shiller index became one of the most widely used housing market indices in developed countries, and the scholars were among the first to point out that the US housing market had gone through a period of excessive price rises and of the risks of booms and busts. Their success with predictions lends valuable validation to the repeat-sales-based housing index approach. 

 

The authors say "the repeat sales approach can avoid the problems with an ever changing sample in the index in the housing market". Alarmingly, the sample selection problem facing the original US housing index approach is nothing compared with the problems in many developing countries, such as China, which have gone through drastic urbanization in the past few decades that would probably be mind boggling in the West. 

 

Let's look at the city of Beijing, which has a ring-road development plan. Starting with the Second Ring Road in the center of the city in the 1980s, it developed with the expansion of the ring system, from the Second Ring in the 1980s, to the third in the early 1990s, the fourth in the late 1990s and the fifth and the sixth ring this decade. 

 

The Second Ring is closest to the city center and is 32.7 kilometers long; the third is 48 km long; the fourth 65.3 km long; the fifth 99 km long and the sixth 192 km long. As the ring road system has grown, Beijing has grown, and many more people now live far from the city. 

 

About 15 years ago when I was a student, the area where the Asian Games Village was considered remote; now it is a coveted central area within the Fourth Ring. Similarly, the region of Wangjing has developed from a remote satellite village that few people lived in or had even heard of 15 years ago into an integral part of the city that now boasts more than 300,000 permanent residents and is home to the China headquarters of many of the world's largest fortune 500 companies. 

 

Ten years ago most of the project housing was built inside the Fourth Ring road; these days much of what is on sale is outside the Fifth Ring road. 

 

As Chinese cities have rapidly expanded over the past decade it has become increasingly important that sampling used in calculating what is happening with prices is consistent. In 2000, new project houses sold on average for: 5,000 yuan ($810; 620 euros) a square meter inside the Third Ring, 3,000 yuan a square meter between the third and the fifth rings and for 1,000 yuan a square meter outside the fifth. 

 

Last year new project houses sold, on average, for 50,000 yuan a square meter within the Third Ring, 30,000 yuan a square meter between the third and fifth ring roads, and for 10,000 yuan a square meter outside the Fifth Ring. 

 

If the geographical dispersion of the new project housing for sale has not changed during the past 12 years, then it is apparent that the housing price in Beijing has increased 900 percent. For example, assuming that among all new projects for sale, half are still inside the Third Ring, 40 percent are located between third and fifth rings, and 10 percent are outside the Fifth Ring, then the average house price in Beijing in 2000 was 3,800 yuan a square meter (50000.5+30000.4+10000.1) and the average housing price in Beijing now is 38,000 yuan a square meter. 

 

However, the reality is that there has been a fundamental shift in the geographical distribution of new project housing. By last year most of it was outside the Fifth Ring. In fact, half the new project housing on sale last year was outside the Fifth Ring, 40 percent between the fifth and third rings, and only 10 percent inside the Second Ring. That means the geographical location of the new housing for sale was the reverse of what it was 12 year earlier. If you calculated the housing index using the methodology of the China Index Research Academy you would conclude that the average housing price in Beijing last year was 22,000 yuan a square meter on average - about half of what you would get had there been no change in the geographical distribution of new project housing on sale. 

 

In percentage terms the difference is even more striking. The method that does not take account of the change in geographical distribution would find that housing prices have risen only 340 percent; the repeat-sale approach comes up with a rise of 900 percent. That problem is not limited to new housing. According to the official website of the China Index Research Academy, the sample used for compiling the price index for existing homes is based on "prices from 'representative' complexes with more active transactions in major areas of the city". 

 

With new projects being ever more widely dispersed and the urban population migrating toward surrounding suburbs, that index is distorted by the big changes in sample composition. 

 

Because of these statistical discrepancies the housing index of the China Index Research Academy greatly underestimates the severity of the housing boom. 

 

Such differences in the methodology and resulting conclusions may explain why, if you use that index, public frustration and anger with soaring prices seems to be an overreaction. 

 

The misleading housing index may also explain why the price-to-rent ratio paints a more worrying picture for the housing market than the price-to-income ratio. The latter takes housing prices from the understated housing index whereas the price-to-rent ratio (rental yield) is less dependent upon sample selection. If anything, the price-to-rent ratio is indeed much higher in outlying areas than in the city center because of more limited demand and low occupancy. 

 

Since 2011 China has implemented a series of policies aimed at reining in house prices. Two years have passed and little seems to have changed. In fact, the housing market seems to be having another bullish year. 

 

In tackling the housing problem and trying to cool the market, the authorities would be well advised to go back to the basics and get the statistics right.