Why It Matters House Price Volatility
Summary
We have calculated the volatility of residential property prices in a postcode, which are expressed as values ranging between -3 and +3. ‘Volatility’ should be understood here as the (in)susceptibility of property prices in a given postcode to change (either increases or decreases in value) within a three year period, relative to average prices and price fluctuations in the whole of the Greater London Area and its surroundings.
A negative value (between -3 and 0) represents a decrease in value, while a positive value (between 0 and +3) represents an increase. The closer the value is to -/+3, the more ‘volatile’ those prices are predicted to be (i.e. property prices are prone to dramatic changes within a short-term period). The closer the value is to 0, the less volatile and therefore the more stable.
Interpretation
| Dataset | Explanation |
|---|---|
| Postcode Average Price Volatility Coefficient for a Flat | This is the volatility coefficient for a flat in this neighbourhood measured over a three-year period. |
| Postcode Average Price Volatility Coefficient for a Detached Property | This is the volatility coefficient for a detached property in this neighbourhood measured over a three-year period. |
| Postcode Average Price Volatility Coefficient for a Semi-Detached Property | This is the volatility coefficient for a semi-detached property in this neighbourhood measured over a three-year period. |
| Postcode Average Price Volatility Coefficient for a Terraced Property | This is the volatility coefficient for a terraced property in this neighbourhood measured over a three-year period. |
| Postcode Average Price Volatility Coefficient for a Residential Property (All Classes) | This is the volatility coefficient for a property of any type in this neighbourhood measured over a three-year period. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Flat | This is the postcode’s Z-score for its price volatility coefficient with regard to flats on the market in the area. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Detached Property | This is the postcode’s Z-score for its price volatility coefficient with regard to detahced properties on the market in the area. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Detached Property | This is the postcode’s Z-score for its price volatility coefficient with regard to detahced properties on the market in the area. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Semi-Detached Property | This is the postcode’s Z-score for its price volatility coefficient with regard to semi-detahced properties on the market in the area. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Terraced Property | This is the postcode’s Z-score for its price volatility coefficient with regard to terraced properties on the market in the area. |
| Z-Score of Postcode Average Price Volatility Coefficient for a Residential Property (All Classes) | This is the postcode’s Z-score for its price volatility coefficient with regard to properties n the market of any type in the area. |
Z-scores are measured in terms of standard deviations from the average. If a Z-score is 0, it indicates that the area’s salary expectations (for each job type) is identical to the London-wide average. A Z-score of 1 would indicate a value that is one standard deviation from that average. Z-scores may be positive or negative, with a positive value indicating the score is above the average and a negative score indicating it is below it.
| House Price Volatility |
|---|
| A postcode’s average house price volatility (i.e. Beta Coefficient) is a positive or negative number that tells you the extent to which you can expect properties in this postcode and of the type selected to move in line with the London-wide average for properties of this type (please see the Definition section below for further details) • A negative volatility coefficient or one less than 0, indicates an inverse relation to the London-wide average price. Although rare, some neighbourhoods actually go up in value when the London-wide market is in decline. • A volatility coefficient between 0 and 1 would mean property of the type selected is less volatile than the overall market and therefore would rise and fall slower than the rest of the market (i.e. values would be more stable). • A volatility coefficient of 1 means that property of the type selected would be expected to fluctuate in price in accordance with the London-wide average price. A volatility coefficient greater than 1 would denote a volatility that is greater than the London-wide average price, and so property of the type selected would be expected to fluctuate in price much more than the rest of the market. |
Definition
The volatility coefficient, measures the degree to which the postcode-wide average price of any of (1) a detached Property, (2) a semi-detached property, (3) a terrace house or (4) a flat/apartment property fluctuates in relation to London-wide average price of any of (1) a detached Property, (2) a semi-detached property, (3) a terrace house or (4) a flat/apartment. It gives a sense of the postcode-wide average price riskiness compared to that of the wider markets’.
A volatility coefficient of 1 indicates that the postcode-wide average prices tend to move with the market. A volatility coefficient greater than 1 indicates that the postcode-wide average prices tend to be more volatile than the market, whereas a volatility coefficient of less than 1 means it tends to be less volatile than the market. Many properties in areas that have been very desirable for as long as anyone can remember, tend to have a volatility coefficient of less than 1, and conversely, many up and coming rapidly gentrifying-areas have a volatility coefficient greater than 1.
In essence, the volatility coefficient answers the fundamental trade-off between minimising risk and maximising return. An example may help. Say a postcode (E20 6PQ) has a volatility coefficient of 2. This means it is two times as volatile as the overall market. If we expect the London-wide average price of any of (1) the detached property, (2) the semi-detached property, (3) the terrace house or (4) the flat/apartment market to increase by 10%. We would expect a detached property, (2) a semi-detached property, (3) a terrace house or (4) a flat/apartment in E20 6PQ to increase in value by 20%. On the other hand, if the London-wide average price were to decline 5% (i.e.-5%), it would be expected that property in E20 6PQ would lose 10% of its value.
Why the metric matters from a commercial inhabitant’s perspective
Understanding the volatility coefficient allows real estate investors to choose whether to take on an amount of price volatility risk equal to the market, greater than, or less than the market, depending on their risk appetite and investment strategy.
One way for a real estate investor to think about risk is to split it into two categories. The first category is called systematic risk (or un-diversifiable risk), which is the risk of the entire market declining. The financial crisis in 2008 is an example of a systematic-risk event when no amount of skill could have prevented the majority of real estate investors from losing some value. Unsystematic (or diversifiable) risk however is risk associated with an individual postcode.
For example, the surprise announcement that Transport for London are closing a new station that serves a previously quite accessible area would be an example of unsystematic risk factor, specific to a neighbourhood. Unsystematic risk can be partially mitigated through investing in a diverse enough range of London neighbourhoods so that the sum of the volatility coefficients of all areas invested is equal to 1.
(Photograph: Basher Eyre, geograph.org.uk)
Why the metric matters from a residential inhabitant’s perspective
Choosing what type of house to live in and where to live and whether to buy or rent, is one of life’s biggest decisions. In addition to absorbing a large fraction of the household budget, where we live and how much we decide to spend on housing determines the amenities and life-style we have available for our families and ourselves. In addition, our residence, can be even more critical as an investment since it is typically by far the biggest marketable asset in the household portfolio for most people.
Therefore, house price volatility matters for residential inhabitants who also view their home as an asset because it is the only way to understand the risk that owning a home in a particular area will expose you to. As house prices cyclically exceed a notional real value and then lag behind a notional real value, knowing the extent to which the price of your property is likely to move above or below the market average limits the risk involved in one of the most critical life choice and investment decisions that individuals and families make involves.
General commentary
Walulel’s volatility coefficient refers to the amount of uncertainty (i.e. risk) related to the size of changes in a property’s value. Higher volatility coefficient scores mean that a property’s value within a postcode can potentially be spread out over a larger range of values. Consequentially, the price of the property’s value within a postcode can change dramatically over a short time period in either direction. A lower volatility means that a property’s value within a postcode does not fluctuate dramatically and tends to be steadier.
The Efficient Market Hypothesis (“EMH”) claims that house prices exhibit systematic short-run and long-run behaviour. In the short run, property prices fluctuate above and below the average price for a property of a given type in a given area and over longer periods tend to revert, that is to say head back towards average price for a property of a given type in a given area. The cause of this behaviour is attributed to the fact that information is not accessible to all market participants and so that is what allows for hotspots and out of favour areas to exist.
History
House Price Volatility Housing prices in London, when compared to UK-wide averages, have historically tended to increase more strongly, however, they are also more volatile. From a historical perspective, during economic booms housing prices have been prone to rising first in London and the south-east and then gradually other regions have caught up. This relates to what has been called the ripple effect: housing prices in London and the South-East are then transmitted to the rest of the country. Nevertheless, researchers have recently started to question the interconnectedness of London and have found that the rest of the UK also bears an essential effect on housing prices volatility in the capital. The UK has experienced four major boom and bust cycles since the 1970s. These correlate significantly with particular national and international events. In 1973 the oil crisis led to negative economic growth and high inflation rates. The economic recession heavily impacted traditional British heavy industries. By 1974 the crisis had expanded to the real estate market with capital values falling 25-50%. This led to a reduction in housing prices in London that struggled to gain previous levels until the late 1980s.
After the deregulation of the mortgage market in the 1980s, lower income groups found it easier to access the housing ladder-albeit through debt. The 1986’s Big Bang in finance led to a set of legal and technological innovations that enabled unprecedented growth and an increase in market activity. A housing boom took place this decade with higher ownership rates motivated for policies such as the right to buy.
The early 1990s saw a new crash in the real estate market. Many owners who relied on high mortgages fell into negative equity. Although the 2008 crash led to falling housing prices, the rampant foreign investment led to the polarisation of London property when compared to other areas of the country where prices were lowering. Right now, while price volatility is slowing down in central London areas, it is speeding up in the rest of the country and the capital.
Nevertheless, despite the property cycles, prices have gone on rising steadily in London for the last half-century. Volatile housing prices are mainly related to other measures like tenure. For instances, higher volatility may be an incentive for individuals to overstretch themselves to buy property, especially in a place like the UK where home-ownership has been socially tied to economic stability and maturity. As a result, when there is negative swing, paying the mortgage can become increasingly difficult with repossessions becoming increasingly common.