9.1 For macroprudential analysis, it is highly desirable to have indices of real estate prices 1 both because deposit takers may have large exposures (both direct and indirect) to real estate and because they may be affected by the potential volatility of price movements. Moreover, real estate assets are a major element of the wealth of the private sector. The direct exposure to risks arising from real-estate- related lending of deposit takers can be monitored through the FSIs related to real estate loans that are described in Chapter 6.
9.2 Deposit takers' exposure to real estate prices can arise because they may
- Own real estate;
- Lend to customers to purchase, construct, or develop real estate;
- Take collateral in the form of real estate;
- Lend to other deposit takers who have real estate exposures or who fund real-estate-related lending;
- Be subject to the risk that real estate loans will be prepaid, which can contribute to balance sheet volatility and asset-liability mismatches;
- Own securities on which the payment of principal and interest is backed by real estate loans;
- Be exposed to the real-estate-related lending exposures of subsidiaries or branches in other economies;
- Be exposed to households and corporations that can be affected by changes in the servicing costs of real-estate-related borrowing and/or price movements in real estate; or
- Be exposed to specific locations (such as tourist facilities or center city offices) that may be subject to more volatile price conditions than in the wider real estate market.
9.3 The reasons why real estate prices are potentially volatile are varied. Real estate markets are illiquid, with sales negotiated with high transactions costs. Supply is inelastic in the short term owing to the time needed to plan projects and complete construction. Development is often subject to many legal or other restrictions, such as a shortage of urban land that can be developed. Under these conditions, the impact of changes in demand on prices is exacerbated. While international capital flows into or out of real estate can rapidly and unpredictably affect market sales and prices, price volatility is also endogenously induced through the provision of domestic credit. During an upswing in real estate prices, real estate may be used as collateral for extensions of credit for further purchases. But once conditions begin to reverse, such exposure can cause the downturns in economic activity, credit, and real estate prices to become mutually reinforcing.
9.4 Constructing representative real estate price indices is challenging. Difficulties can arise because real estate markets are heterogeneous, both within and across countries, and illiquid. There may be no unambiguous market price. Moreover, such diversity and lack of standardization result in the need to gather a wide range of data to compile indices that are characteristic of the various market segments; this contributes to high data collection costs and may require greater technical sophistication. Representative real estate prices in residential and commercial markets can be hard to measure accurately given the small samples that are often available, as there may be disparate prices for apparently similar properties Page 102 and prices may be volatile. Experience has shown that there are particular difficulties in measuring commercial real estate prices across the economy.
9.5 The measurement problem is compounded by the significant differences in price information on real estate transactions, differences that depend on the stage in the transactions process at which the data are collected. It is possible to construct a timeline- which can cover a half-year or more-of the stages in the real estate transactions process:
- Advertisement of the property and its asked price,
- Verbal agreement to purchase at a negotiated price,
- Approval of mortgage financing,
- Agreement on contract,
- Completion of transaction,
- Registration of transaction or deed, and
- Valuation assessment. 2
9.6 To understand the properties of the price series compiled, it is important to know the stage in the timeline of transactions at which the information is collected. At each stage, different types of coverage, prices, and data sources may be involved. For example, advertised prices available from brokerage firms often exceed the negotiated sales price, which in turn may be different from the amount of the mortgage, as the latter might include fees and exclude cash contributions. Data on advertised prices provide first indications about price trends but are often incomplete and do not reflect actual prices and transactions. Conversely, information provided at the registration of a transaction can be the most complete, as it can also include privately arranged sales, but it may seriously lag behind transactions and turning points in prices. Similarly, mortgage-based information is sometimes highly detailed regarding the characteristics of the property, but it can be proprietary, limited in coverage, or compiled differently by different lenders. The nature of the information derived at different stages of the transaction can also vary depending on the country. Clearly, these differences can affect the analytic uses of the price series compiled.
9.7 Moreover, there is limited international experience in constructing representative real estate price indices. Although compilation of information on real estate prices is a part of the measurement of the national accounts, and such prices are included in many countries' consumer price indices, little attention has been paid to the construction or dissemination of real estate price indices in many countries. Compilation efforts have been constrained by the high cost and technical difficulty involved, the limited demand for such data in the past, and the proprietary control of much of the key detailed data useful for compiling indices. Indeed, in many countries, the compilation and dissemination of real estate indices are undertaken by private corporations or associations involved in the various real estate transactions mentioned above that have good access to data and commercial reasons to compile the indices.
9.8 Given the relative lack of international experience in constructing real estate price indices, the cost of creating real estate price indices, and the diversity of users with needs for different types of real estate information, the Guide does not recommend a single set of indices or compilation methods but describes a range of techniques whose application can be based on local needs, conditions, and availability of resources. Nonetheless, the Guide does recommend that separate indices be compiled for residential and commercial real estate, because of the very different conditions prevailing in the two markets. To capture changes in real estate price...