Loading ...Because there are only a half dozen or so indexes out there … sorry, I’m being told that’s actually a half million. Oh well, too late! I’ve already created the index and feel compelled to announce it. Drumroll …
Easynomics Real Estate Price Stability Index (EREPSI)
First off, it’s clear that I picked the acronym first (it’s so catchy!) and worked my way backward to think of what it stands for. Anyway, let’s get to the why, what and how of the index.
Why did I create this index?
Simple. I see all kinds of housing indicators out there, but none of them seem to encapsulate in one number the thing that I’m personally looking for. I want to know how close we are to achieving a balanced state of equilibrium in the price of real estate. That is, are we close to a situation where there isn’t a bubble or a depression in any area of real estate. The best way I could think of capturing that was to look at three indicators that all relate to price stability. This is NOT a scientifically validated index with any special adjustments or complex calculations. In fact, for now, one of the components of the index is an eyeball estimate from looking at a chart! Maybe I should have called it “Lazynomics” bla bla? But who cares? I’m not using it to make investment decisions, and neither should you. It’s just an easy way for me to comment on housing in my weekly indicator roundup.
What makes up the index?
There are three components:
- New Homes Inventory Months of Supply(Source: U.S. Census Bureau) - When there are too many new homes still left unsold (inventory) on the market, it usually means that prices will be dropping because supply is greater than demand. The opposite is also generally true. A good way of measuring the inventory is to calculate how long it would take that inventory to sell at the current pace of sales. The normal level for this is around 6 months.NOTE: Data for this indicator lags considerably. In addition to the index that is based on all available actual data, I will also calculate an index using the Easy Trends projection for the latest month, which basically assumes the recent trend will continue. If there is no projection, I will assume the latest month’s data is the same as the previous month and calculate the index with that.
- Existing Homes Inventory Months of Supply(Source: National Association of Realtors) - Same concept as “New Homes” above but with homes that already have an owner.NOTE: Data for this indicator lags considerably. In addition to the index that is based on all available actual data, I will also calculate an index using the Easy Trends projection for the latest month, which basically assumes the recent trend will continue. If there is no projection, I will assume the latest month’s data is the same as the previous month and calculate the index with that.
- Price-to-Rent Ratio (Source: Until I figure out how to do the calculations myself, I am “eyeballing” this from the monthly chart on Calculated Risk.) - Comparing the prices of homes to the equivalent price of renting a similar home is a good way to gauge whether there is generally more incentive to buy or to rent. Based on what I’ve seen, the normal for this ratio is approximately one, so if this number is higher, it means home prices are more likely to fall. The opposite is true if the ratio is below one.NOTE: Data for this indicator lags considerably. In addition to the index that is based on all available actual data, I will also calculate an index assuming the latest month’s data is the same as the previous month.
How is the index calculated?
The index is the equally-weighted average of the deviation from normal for these three components. Although there are a ridiculously higher number of existing homes than there are new homes, the sale of each new home is much more important to the economy (GDP), so I didn’t feel that I should weigh one more than the other.
Example: For a given month, if the new homes months of supply is 7.5, and the existing homes months of supply is 5.5, while the price-to-rent ratio is 1.10, the calculation is as follows:
- Deviation for new homes months of supply is 1.5 months (because normal is 6 months). 1.5/6 = 25% (rounded) –> I convert this to negative because it’s in the direction that hurts home prices.
- Deviation for existing homes months of supply is 0.5 months (because normal is 6 months). 0.5/6 = 8.33% (rounded) –> I keep this number positive because it’s in the direction that favors existing home prices.
- Deviation of price-to-rent ratio is 0.10 (because normal is 1.0). That’s 0.10 divided by 1.0 = 10% — I convert this to negative because it’s in the direction that hurts home prices.
- Final calculation is the average of: -25 percent, +8.33 percent and -10 percent = -8.89 percent.
Watch for this week’s indicator roundup for your first look at the value of this index!
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