House Price Index and its shortcomings

What is Housing Price Index (HPI)?

The Housing Price Index (HPI) is published by the National Housing Bank (NHB) to track the movement in property prices across 50 major cities in India.

It serves as a major macroeconomic indicator and is a crucial tool for analyzing economic trends because the value of properties impacts borrowing levels and consumer spending.

HPI also aims to increase transparency in the Indian real estate market by helping property buyers estimate the true value of properties.

However, at times it falls short in accurately reflecting the actual increase in property prices.

Reliability Issue with HPI

According to the index, a property purchased for 100 Lack rupees in Delhi in 2013 would only be worth 97 Lacks today, indicating a decline of 0.3% per year. 

However, if you ask a real estate broker, he would quote you a significantly higher price for that property.

This disparity between HPI and actual property prices is due to the way HPI is computed.

Computation Methodology

HPI is calculated by observing changes in the average selling prices of properties in various areas within a city; weights are allocated to these areas, and an index is computed for the city as a whole. 

However, the problem lies in the fact that the computation of the index is based on “registered price”  information which is often not the actual transaction value. 

In India, property taxes are ad-valorem, meaning that the taxes are levied on the transaction value.

This means, the higher the translation value, the higher will be the tax, and vice versa. 

Consequently, homebuyers often understate the transaction value to reduce their tax burden and settle the difference in cash. 

If the proportion of cash settlement varies across the years, HPI will fail to reflect the true changes in property prices. And this happens a lot.

For example, around demonetization, the supply of high-denomination currency was very low, hence, the registered transaction value would have had a low portion of cash compared to some other period.

Impact of Cash Settlement

Considering the previous example where the property had a registered purchase value of 100 Lacs in 2013, let’s assume that the cash portion of the transaction was 20% (though it can be higher, sometimes around 50%). 

In this case, 25 Lacs (100/0.8*0.2) would have been settled in cash, and the actual transaction value would be 125 Lacks.

If the same property were sold today, but this time the cash portion of the transaction was 40%, the index would show no change even if the actual property value increases by 33%.

HPI has some serious limitations due to the way it is computed.

It is important to recognize its shortcomings and consider other sources of information to obtain a comprehensive understanding of property price movements.