Home ownership in the Consumers Price Index

The purchase of new housing index had an expenditure weight of 4.66 percent of the Consumers Price Index (CPI) at the June 2006 quarter. This article looks at the conceptual approach to measuring home ownership costs in the CPI and the methods used to compile the purchase of new housing index.

A brief history of home ownership in the CPI

1948

The first revision advisory committee (RAC) was appointed by the Government in 1948 to review the compilation of the CPI and to identify the various theoretical concepts to be used. They recommended that the CPI regimen should not be limited to essential commodities but should also cover "the whole range of commodities and services used in the average household – with representation as far as possible, of the amenities of modern living." The major changes to housing in the CPI was with the housing group, which now incorporated rented dwellings and the cost of owner-occupied housing. A consumption-based 'user cost' approach (incorporating measures such as return on capital and depreciation) was used to measure owner-occupied housing.

1974

A fundamental conceptual change was made to the CPI at the time of the 1974 revision, from a consumption-based to an expenditure-based approach. This greatly affected the treatment of owner-occupied housing, with estimation now based on the purchase and construction of dwellings, rather than on the user cost of housing. The price indicator for dwellings reflected the price movements of both new and previously occupied dwellings. Mortgage interest rates were also included in the CPI.

1980

A major change was made to the way that the overall weight for the purchase and construction of dwellings was derived. In the 1974 and 1977 revisions the weighting calculation incorporated the expenditure of households either acquiring a dwelling, or selling a dwelling and buying a replacement. In the latter case, the net cost (that is, the difference in value between the sale and the purchase prices) was used in the calculations. The 1980 revision reflected the net proceeds of all purchases and sales made by households, including cases where households sold dwellings and did not make corresponding purchases. This more-complete method of netting was in accordance with the recommendations of the 1978 RAC and resulted in a considerable fall in the weights given to the direct costs of purchase and construction of dwellings.

1993

Following a recommendation from the 1991 RAC, the price indicator for dwellings was adjusted to represent the price movements of new dwellings only. Prior to the revision, the price changes of previously occupied dwellings were also included.

1999

From the September 1999 quarter onwards, mortgage (and other) interest rates and residential section prices were removed from the All groups CPI. An analytical series of the All groups CPI plus interest continues to be made available in table 3 of the quarterly CPI release.

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Conceptual approach

There are three main conceptual approaches that can be adopted when constructing a CPI – the uses, payments and acquisition approaches. These approaches address different, although related, questions: ‘What is the change in the cost of living?’ (uses), or ‘How has household purchasing power changed?’ (payments) or ‘What inflation rate have households faced?’ (acquisition). For most goods and services in the CPI basket, the acquisition, uses and payments approaches coincide. However, the most significant area where this is not the case is owner-occupied housing.

As the fundamental purpose of a CPI is to measure the changing cost of consumption or expenditure for consumption purposes, investment expenditure is considered out of scope. However, owner-occupied housing can be regarded, from a household perspective, as serving two roles; one, to provide shelter and security of tenure; two, as a means of investment. These two roles can lead to its divergent treatment within CPIs. Owner-occupied housing can be regarded as:

• a capital good
• a consumption good
• both a capital good and a consumption good.

Statistics New Zealand uses the net acquisition approach to estimate the costs faced by households. If the main objective of a CPI is to measure inflation, as is the case with the New Zealand CPI (this was confirmed by the 2004 RAC), an acquisition approach is an appropriate way of measuring owner-occupied housing.

Under the net acquisition approach, the expenditure weight allocated to purchase of housing represents the value of the net increase in the stock of owner-occupied housing during the weight reference period. Expenditure on newly constructed dwellings by owner-occupiers is included, as are any net shift between owner-occupied dwellings and rental properties, and alterations and additions to established owner-occupied dwellings.

Sales within the household sector of established owner-occupied dwellings do not add to the stock of owner-occupied dwellings, as netting results in each purchase (positive expenditure) being cancelled out by a corresponding sale (negative expenditure). However, any net shift of dwellings in either direction between owner-occupation and renting or small-business use should be included, as it would result in a net addition (towards owner-occupation) or net reduction (towards renting or business use) to the stock of owner-occupied housing.

Other types of expenditure associated with home ownership are also included within the scope of the CPI. These include local authority rates and property maintenance (within the housing and household utilities group), and dwelling insurance, conveyancing legal fees and real estate fees (within the miscellaneous goods and services group).

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Position in CPI structure

The following table shows that the position of the purchase of new housing index falls within the housing and household utilities group of the New Zealand Household Expenditure Classification used for the CPI.

 

The expenditure weight for purchase of new housing was derived using data sources other than the Household Economic Survey (HES). Information from the HES, the most common source of CPI weights, was not used, partly because it was considered less reliable given that purchases of new housing are made relatively infrequently, resulting in a relatively high sampling error. The expenditure weight allocated to purchase of housing represents the value of the net increase in the stock of owner-occupied housing during the weight reference period.

The method used in 2006 involved applying an average new private dwelling value to the net change in the number of owner-occupied dwellings, then adding an estimate of owner-occupiers' share of the value of residential building additions and alterations to established dwellings. This differs from the 2002 reweight, where the method used to derive the expenditure weight for purchase of housing was to estimate owner-occupiers' share of the value of new residential building work put in place (including alterations and additions).

The net change in the number of owner-occupied dwellings reflects the overall effect of households:

• acquiring newly constructed dwellings for occupation
• demolishing established owner-occupied dwellings
• selling established owner-occupied dwellings to landlords, small businesses, developers or government
• acquiring established dwellings (for owner-occupation) from landlords, small businesses, developers or government.

The underlying assumption in 2002 was that there had not been any, or any significant, net shift in either direction of established dwellings between owner-occupation and renting or small-business use. However, information from the Census of Population and Dwellings, the HES and other sources indicates that there has been a trend over a lengthy period towards lower home ownership rates.

For the 2006 CPI review, the weight reference period was extended to incorporate the three years ending with the HES period to derive annual average CPI expenditure weights for the purchase of housing (and related services such as conveyancing and real estate fees) and rentals for housing, to smooth the impact of cyclical highs or lows in activity. For the 2006 CPI review, information for the three years to June 2004 was used.

Estimates of the numbers of owner-occupied dwellings for the years to June 2001, 2002, 2003 and 2004 were used to calculate the net annual change for each of the three years to June 2004. These net annual changes were multiplied by the average cost of constructing a new dwelling during the year to June 2004 (derived from Statistics NZ's Building Consents statistics and Value of Building Work Put in Place statistics). Figures for each of the three years to June 2004 were averaged.

The values of residential building additions and alterations to established dwellings for the years to June 2002, 2003 and 2004 (from Value of Building Work Put in Place statistics) were multiplied by extrapolated home ownership rates, to estimate owner-occupiers' share of the value of improvements to established dwellings. Figures for each of the three years to June 2004 were expressed in 2003/04 prices, averaged, then added to the annual average value assigned to the net change in the number of owner-occupied dwellings.

The final step was to price update to the June 2006 quarter. The price updating indicator that was used for purchase of housing was not the CPI index for purchase and construction of new dwellings; rather, an indicator based on Building Consents and Value of Building Work Put in Place data was used. This was to reflect an increase in the size of new houses since 2003/04 (as shown by Building Consents data) and to reflect increased costs as a result of the introduction of a more stringent building consents and inspection process. Changes to the building consents regime have in some cases resulted in improvements to the materials used in constructing, and the quality of, new house plans being tracked in the CPI survey. The impact these improvements had on surveyed prices was stripped out of the CPI index for purchase and construction of new dwellings (discussed later in this article under 'Quality adjustment').

Notes:

1. For the purposes of deriving the CPI expenditure weight for purchase of housing, households holding the homes they occupy in family trusts were treated as being owner-occupiers (even though this might not be true in a strict legal sense).
2. Expenditure by landlords on, or relating to, the properties they rent out is not included in the CPI.

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Sample selection

A sample of builders has been reselected three times since 2002. Members of the Master Builders Federation are selected using building guarantees data for inclusion in the CPI purchase of new dwellings survey. The data contains information on the number of building guarantees on dwellings constructed by master builders throughout New Zealand and is stratified into the five broad CPI regions: Auckland, Wellington, Christchurch, Rest of North Island and Rest of South Island.

A cut-off sample approach has been used where builders with four or more guarantees per year in any one of the five broad regions are included for initial selection in the survey. The final sample is selected by identifying builders within the initial selection that are able to provide prices for a standard house plan.

The sample was last reselected in 2004 and consists of about 140 builders providing prices for about 215 house plans. These builders are located throughout the country, not only in the 15 CPI urban areas.

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Price collection

Price change is based on the price for constructing a new dwelling, from a survey of builders that construct standard-plan houses. Respondents are asked to provide a quote for a house plan that they build fairly regularly. Larger building enterprises (based on the number of buildings constructed) are asked for two such plans, while smaller building enterprises are asked to provide one plan.

The following survey information is requested from respondents:

• name of the house plan
• floor area of the house in square metres
• number of bedrooms
• important features of the house (for example, double garage, en-suite bathroom, study)
• price (at the mid-point of each quarter) to build the house on a level, fully-serviced section owned by the client
• any changes to construction components or fittings
• contact information.

Further, when the price for the provided quote changes, respondents are asked to indicate reasons for the change. The following options are given on the questionnaire (in the order that they appear on the questionnaire):

• price of construction components
• price of fittings
• labour costs (this includes staff recruitment and changes to existing salaries and wages)
• sub-contractor charges
• consent fees and other local authority charges
• other administration costs
• reaction to competitors' prices.

Respondents are also asked to provide:

• any comments that may help Statistics NZ understand any of the quote change reasons ticked above
• any other reasons for the quote change
• how any construction components or fittings have changed.

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Quality adjustment

As with all price index collections, efforts are made to ensure that changes in price quotes reflect constant quality. Respondents are asked to provide a quote for the same standard plan each quarter. Further, it is assumed that the house will be built on a level, fully-serviced section and that the section is not part of the price.

When any of the information about a standard plan changes, or the plan itself changes, quality assessments are made. This usually occurs after consultation with the builder in question, to remove any change in the quote that can be attributed to quality change.

The introduction of the Building Act (2004) resulted in improvements to practices and materials used in constructing new house plans, including those tracked in the CPI survey. The value of any improvement in materials and the value of any additional labour resulting from improved building practices were removed from any quote increases, as these were regarded as improvements in quality. In addition, as increased consent fees and other local authority charges were often reported as a reason for increases in prices, a proportion of this was removed. This proportion was removed as it was deemed to be attributable to an increase in the overall quality of the dwelling, through better monitoring of building practices.

The latest amendment to the Building Act 2004 resulted in the introduction of compulsory double glazing of windows and more stringent insulation requirements for new dwellings. This took effect on 31 October 2007 for new dwellings constructed in the South Island and on the North Island's central plateau, and will apply to all dwellings late in 2008. Any changes reported by respondents in the South Island and central plateau to the components and materials of the house plans, as well as additional labour costs associated with installing these are being carefully monitored to ensure that any quality increases associated with the amendment to the act are removed.

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Estimation

Prices provided from respondents are stratified into the five broad CPI regions: Auckland, Wellington, Christchurch, Rest of North Island and Rest of South Island. Weighted arithmetic mean prices are calculated for each broad region (below the published level), with each quote representing the number of consents issued per year to the master builder, rated up to reflect all consents issued to master builders and to other builders. In each case where two quotes are collected, the weight attributed to the builder is split between the two quotes.

Missing quotes are imputed using class arithmetic weighted mean movements (after quality adjustment). The class is defined as other plans within the same broad region, and an arithmetic weighted mean movement (excluding the missing quote(s)) is calculated (for the class) and applied to the previous quarter's quotes for respondents with missing quotes for the current quarter.

Movements in the weighted arithmetic mean prices for the five broad regions are used for each of the individual 15 CPI urban areas (for example, the Rest of South Island movements are used for each of Nelson, Timaru, Dunedin and Invercargill). Movements for the 15 CPI urban areas are then combined using expenditure weights based on regional population shares to derive the national index for purchase of new housing.

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