Median Values - A New Way of Looking at Things
You might save yourself from an investment mistake if you understand the difference between median prices and median values.
Information about the property market is now hot stuff. Barely a week goes by without another newspaper report listing the top growth streets or the latest growth suburbs. Facts and figures are quoted everywhere. The figure that often gets bandied about the most, though, is the word "median". You'll often hear it in this type of context:
Barry and Steve, two enthusiastic property market followers, are discussing a suburb of Sydney and Barry says, "Oh, have you seen what the latest median is this quarter for that area? It's such and such." To which Steve will reply, "That's a lot higher than last quarter. House values must really be going up in that suburb!"
But what Barry and Steve may not have realised is that there's a bit of an assumption that was made in that conversation that may not have been correct. The assumption is that the change in the median price is a reflection of the change in house values. This is actually a fairly common assumption shared by many investors, so it may surprise some of you to read that it can actually be incorrect.
if most of the property sales occur in one end of the market, the median sale price becomes an unrealistic representation of the market.
The problem arises because of the limitations that exist with median prices. You can see these limitations just by taking a moment to think about the name: median price. The first word "median" refers to the middle number in an ordered list, which most of us understand. "Price" refers to the sale prices of houses over a period of time. (Usually quarterly.) So the "median price" is simply the middle figure of all the sales that have taken place.
The reason why the assumption about median prices being a reflection of house values has problems is that house prices only tell you about house sales, not house growth. Only some of the houses sell; all properties change value.
As an example, consider Table 1. Smith St is a fictional street that is designed to give us an understanding of the problems that can occur when we use the median price as an indicator of the value of a property.
For each of the 20 houses in the street, we'll imagine that we've had them valued and that is what they're worth.
Let's assume that over a period of 12 months, the properties grew in value by 9%. 12 months later, their values have grown by 9% to the figures listed in Table 2.
In Chart 1, we have drawn a graph of the spread (or frequency distribution, to use a statistician's favourite word) of the houses' values and we can see that the values are fairly evenly spread but most of them are around the $600,000-$800,000 mark. So we would expect a figure like a median, if it's going to be useful and realistic to us, to be somewhere in that price range.
Now let's assume that at the end of these 12 months, some of those houses sold and fetched the values listed in Table 2. Let's assume that there were 7 sales, houses #2, #5, #7, #8, #11, #16 and #19. If we calculated the median sale price (the middle price when we list them from smallest to biggest) the answer would be $730,300. (This is marked by XM on Chart 1.)
This seems okay. At first glance, this seems like a good indicator of the value of properties on Smith Street. But let's consider a couple of alternatives. What if there were only five sales and they were the cheaper houses on the street? What if it was houses #2, #3, #5, #8 and #13? Then the median house price would be $414,200 (marked by XL on Chart 1). This is far too low and makes the houses in the street seem worth less than they actually are.
What if it was five houses from the more expensive part of the street? Say, #10, #14, #16, #19 and #20? Then the median sale price would be $991,900 (marked by XH on Chart 1). This median makes the houses in the street seem worth a lot more than they actually are.
As you can see, if most of the property sales occur in one end of the market (the upper or the lower), the median sale price becomes an unrealistic representation of the market. This is because, obviously, the median sale price only tells us about the houses that sell! To really understand what houses are worth and what values in an area are, we need information about all the houses in the area, not just the ones that sell.
It is for that reason that Residex has started calculating and publishing median values instead of median prices.
Residex has thrown a large effort estimating property values over the years. Recent fine tunings during this year have brought our estimation efforts to new heights in being able to realistically estimate the value of a property at a particular point in time. So every house on our database, whether it has sold recently or not, is assigned a statistical value estimate.
It is the median of these value estimates that we are using. (In our example of Smith St, the median value works out to be $708,500, which is represented by an O on Chart 1. You can see straight away that this is much more realistic.) We can now get the median of all the properties in an area, not just the ones that sell. Our preliminary trials with the median value have indicated that it provides a much more realistic picture of what is happening in the market.
For example, the median sale price in the June 2003 quarter for the Sydney housing market was $470,000. But due to the fact that a large number of the sales that were used in this median calculation were taking place in the cheaper outskirts of Sydney, the median sale price was actually underestimating the values of properties in Sydney.
In the September 2003 quarter, we calculated a median value of $551,000 which is a lot higher but also more realistic. (It also intuitively should make more sense to Sydney investors, who were probably wondering if there really were 50% of houses out there that were worth less than $470,000.)
So now when Barry mentions the median price in an area, Steve will be able to say, "Ah, yes, but that's because the last quarter has shown a lot of demand for cheaper housing in the area. But if you look at the change in median values, there's actually been 6% growth in house values in the area."
The median value may take a little getting used to, especially since the media and a lot of investors refer to median prices as "the median", but with time, this more accurate indicator of the market will come to be another valuable tool for analysing the markets.
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