18 March 2011

The median folly

Hypothetical scenario: the newspapers report that median house prices rose 10% in your suburb last year. 

As a property investor or home owner, do you celebrate the fact that you’re sitting on a 10% profit?  As a renter, do you lament the fact that you’ve missed out?

Before you answer, the issue I’d like to address in this post is whether it is reasonable to assume that property investors and home owners in the above scenario are in fact (on average) sitting on a 10% profit.  In other words, can we assume that a 10% increase in the median house price means a 10% average return?

Let’s work through a very simple example. We’ll put aside the issue of dodgy stats provided by vested interests, and assume that the stats are 100% accurate.  OK, here goes:

There are three properties for sale in your suburb.  This is what they sell for in Year 1:

Property A: $500,000
Property B: $635,000
Property C: $700,000

The median (which is the preferred measure) is the middle number in the list when placed in order.  Therefore, the sale of Property B gives the suburb a median price in Year 1 of $635,000.

Now, for simplicity, let’s assume that the exact same three houses are sold again one year later.  Let’s also assume that house prices remain flat over that year.  Before selling, the owner of Property A knocked down his dump and re-built a brand new home. He spent $300,000 which, let’s assume for simplicity, added exactly $300,000 to the value of the property. 

Therefore, in Year 2, the three houses sold for:

Property A: $800,000 ($500,000+$300,000)
Property B: $635,000
Property C: $700,000

If we were to re-order the above list, we’d find that the middle value is now Property C at $700,000. Therefore, the median house prices has “soared” from $635,000 to $700,000 – a 10% increase in just one year and everyone in that suburb thinks they’re now sitting on a gold mine.  Of course, in actual fact, no one made a paper or real profit – all three property owners above actually broke even.

The point is that all the millions of dollars spend on renovating, maintaining and re-building property artificially inflates the index.  In the above example, even if property prices had fallen slightly over that year, the index would still have shown a gain.

The same principal applies to an individual property.  You often hear people saying “I bought a property 10 years ago for x amount and sold it for x (higher) amount”.  Of course, that’s only half the story.  Then again, it wouldn’t sound as impressive if they said “I bought a property for x amount, spend x on stamp duty and other costs, spent x on repairs and renovations, then sold it for x (slightly higher) amount.

Interestingly, the same issue doesn’t apply to share indices, which is an important point for those comparing the performance of house prices to shares.  With shares, investors cannot tip extra money into a company and inflate its share price.  When a company asks shareholders for more cash, they want something in return – more shares, which dilutes the value of existing shares, lowering the average price.

So next time you hear that house prices rose by a certain percentage, don’t assume that the increase in median sales price is the same thing as profit. There’s that pesky detail of expenses that should also be factored into the equation.

Although I suspect that property investors suddenly remember this fact come tax time.

Comments welcome.



  1. Interesting theory. But does this work with larger numbers of properties? Let's say we have 100 properties, of which 2 people develop their property in that year. The other 98 properties DE-value because they are now all a little bit older. Perhaps that can move the median too. I'm not sure if one outweighs the other, but it's certainly an influencing factor.

  2. Chief Squirrel18/3/11 11:14 AM

    Alarming new research has shown that up to 57.3% of all statistics are incorrect!

  3. Peter Fraser18/3/11 12:00 PM

    Chief Squirrel - nice little joke - thanks.

    Andy is correct about the median prices, but again it is the long term trend that counts.

    The smaller the dataset, the less reliable it becomes. that is why newspapers print rubbish articles about suburbs jumping 45% in one month - of course it can't happen like that, but the stats can mislead in the short term.

    Andy you will love this article -


  4. Thanks PF – yes I did enjoy that article. Although I enjoyed Kris Sayce ripping it to shreds more - Money Morning

  5. Peter Fraser18/3/11 4:26 PM

    Yes I was puzzled by Bloxhams language, he does seem optimistic, even more than I am.

    I'm quite sure we are goinf through a down phase, but I'm not convinced it will be either deep or long. The number of listings seems to be reducing in Qld, so after a period of no interest rate rises, it could well firm up a little.

  6. David - your comment actually raised two issues:

    Firstly, regarding the devaluation that occurs as properties age – yes this would put downward pressure on the median, but rightly so, because it represents a real reduction in value. The improvements that I mentioned inflate the median, but don’t take into account the money spent to make the improvement.

    As to whether the theory still holds for a larger number of properties, yes it does – although of course, the extent to which depends on the proportion of properties being improved.

  7. Good work enjoyed the article look forward to the next

  8. PF

    Number of listings reducing in QLD you say?
    I'm assuming that does not include the Gold Coast, where i can tell you the number of listings is increasing by the week

  9. The Gold Goast has only ever been a speculators market... As other coastal holiday destinations are... Buying in these areas are only for the professionals, the mugs or the professional mugs (insert JB here!)

    It truely is a suckers market...

  10. Peter Fraser18/3/11 9:38 PM

    JB _ I check a few local suburbs that's all. I'm not sure about the greater SEQ area.

    Did you find that silver blogsite?

  11. mildredalston18/3/11 9:39 PM

    After what seemed like a lifetime of thirty-Year adjustable-rate mortgages, with monthly mortgage payments going up all the time, The "Mortgage Refinance 123" helped me to lock in a great low fixed rate of 3.16%, helping me to guarantee myself the ability to always make my mortgage payment on time with money to spare.

  12. This whole scenario iis irrelevant if you don't sell your property to realize the appreciation, so there is no gain or loss to celebrate. Also there is no such thing as artificially inflating the index. The index is based on properties being sold. If no properties sell in a month what is the index then? A big fat zero because property is then worth nothing as the market dictates the price. In addition what mputs more money into your pocket? Propert A that is bought for $500000 and costs $x per year and is then sold 20 years later at roughly $1000000 or spending $20000 a year in rent and then having nothing to sell. If you can afford........ Buy buy buy!

  13. PF

    yes - thanks for that!
    How do you expect to ween me of my addiction now?
    That was like giving an addict the address of a coke factory ;p

  14. Anon:
    i dare say you are correct about the Gold Coast.
    but i'm counting on that very fact now - a few years down the line i will purchase my waterfront McMug Mansion cash and can guarentee you i'll be thoroughly enjoying the holiday atmosphere!!

  15. Gary - you appear to have completely missed Andy's point. The index does not account for input costs into properties - it's not that complicated.

    To answer your question - the renter will come out ahead BY FAR! However, i must qualify that by saying that said renter would have to invest the savings (difference between buying and renting) for this to be true.
    Many Ozzies are just plain mugs and wouldnt have the disciplin or knowledge to invest. But i think it comes down to lack of disciplin mainly because even if they knew nothing about investing and simply placed the savings in a high interest bearing account i believe they would still end up far ahead of somebody who had bought and equivalent home during the last 10 years.

    it's simple arithmetic really

  16. Peter Fraser19/3/11 10:08 AM

    JB - I don't mind if you invest in silver, I was just concerned that it was a "blind faith" investment.

    Now you should have access to much better information, and you can make more realistic judgements.

    On you argument with Gary, I believe it is you who have the arithmetic wrong. It is extremely rare for long term renters to accumulate any sizeable investments, but most homeowners do.

  17. PF
    the fact that most renters dont accumulate sizeable investments has nothing to do with my arithmetic being wrong and everything to do with the lack of disciplin in people.
    when i'm fortunate enough to rent again i'll be investing every spare cent i have and this will be equivalent to building a huge lever with which to "move" property into my possession with ease (cash) ...

  18. Pete,


    I've got this chart from the latest "'BurbWatch Project" update:


    (from: http://burbwatch.wordpress.com/2010/10/04/queensland-qld-info-and-charts/)

    Shows a fairly consistent trend of increasing sales since mid-Feb 2011, with simultaneous decreasing rents (but I wouldn't be surprised if sales-listings start to decrease again, and rent listings start to increase, as they seem to be cycling around eachother in most states).


  19. Peter Fraser20/3/11 9:18 AM

    JB - your strategy might work well for you, but due to that ill discipline that most have it won't work for them.

    Remember that if you put off buying for 5 years, and then buy, you will be at least 5 years of rental payments behind someone who buys immediately assuming that all things remain equal.

    You consider that you have made a mistake buying at the peak in 2008 on the Gold Coast, and frankly I agree, you made a basic mistake, but the tactic from here on should be to make the best of it. Have you considered renting your own home out and renting accomodation for your family. That may give you some tax deductions that might work in your favour.

    May I ask why on earth did you buy in 2008 when it was absolutely obvious what was going on. It's not as though the GFC was a secret at that time.

  20. Andy, your concerns about the median are quite valid when looking at RAW median data, as produced by the REIA, REINSW etc. These organisations publish raw data that is quite volatile and strongly affected by compositional changes, in part due to the reasons you mention.

    However the other data providers (ABS, APM, RPData and Residex) publish stratified/hedonic indices rather than (or as well as) raw medians. These stratified/hedodic indices attempt to correct for compositional changes and price growth caused by improvements to the dwelling. These indices tend to be much less volatile (smaller quarterly gains and falls).

  21. Peter Fraser20/3/11 9:43 AM

    Andy - another of my posts went to your spam bin it seems.

    Stewart - not sure if this will post - thanks for that graph. Too hard for me to see any trend in a few months, but listings do seem to have increased as you say.

    The floods during that period have likely caused some change to the listings, and demand for rental properties.

    In Qld the market has been down for about 12 months or more in holiday areas. I don't think there will be a lot more downside, but it won't turn up for a while either.

    Are you the stewart from talkfinance?

  22. PF – re “Remember that if you put off buying for 5 years, and then buy, you will be at least 5 years of rental payments behind someone who buys immediately assuming that all things remain equal.”

    Yes, they will have paid an extra 5 years of rent. But they also will have earned 5 years of interest on money the money that would have been used for a deposit. And because renting is currently much cheaper the owning, they will be able to save a larger deposit, saving on interest when they do buy.

  23. As to Gary and JB’s discussion about buying vs renting, I put Gary’s example in the New York Times buy vs. rent calculator:

    My assumptions were:
    Monthly rent - $1,666
    Home price - $500,000
    Down payment (deposit) – 20%
    Mortgage rate – 7%
    Annual home price and annual rent change – both 3%

    The result is that buying is still not better than renting after 30 years.

    Nevertheless, I’m not advocating renting forever. But rather buying (if that is your preference) when the house price to rent ratio moves much closer to its long-term trend. Only when that happens will buying buying will be the clear winner.

  24. Peter Fraser20/3/11 1:56 PM

    Andy - I prefer to calculate on 100% borrowings and I use a 5% return on rents, 4% capital gains, and a CPI of 4%.

    I also use an interest rate of 7.5%

    That takes into account the earnings on the deposit, and is pretty realistic in the other factors, although the official CPI is less than the 4% I allow.

    I get different results.

  25. PF - what annual rent increase did you use - and what was the end result?

  26. Peter Fraser20/3/11 3:08 PM

    Andy - in Australia the cpi is really also the rental increase because they use rents in the cpi calculation - so use 4%.

    As I said earlier that is above official figures, but we all know that 4% is closer to reality than the official basket of goods and services.

    Here is a thought for you - we are now building the next housing boom - can you see the building blocks, and what are they?

  27. No idea PF - what are they?

  28. Peter Fraser20/3/11 3:30 PM

    The building blocks are:-

    1. House price correction.

    2. Period of rental increases.

    3. Interest rate falls.

    4. Realisation that loan repayments are much the same or less than rental payments.

    5. Boom...

    In Qld we are about halfway through phase 2.

  29. I agree with those phases. But I don’t think any capital city is much past the start of phase 1.

  30. Peter Fraser20/3/11 4:37 PM

    Phases 1, 2, and 3 can run concurrently and they can last a while, it doesn't get done in 12 months.

    I don't think any of the major capital cities will experience the same market conditions simultaneously. I half expect Brisbane to be coming out of recession while Melbourne is still in the initial phases. That 27% rise in median during a GFC has to be worked off at some point.

    Sydney on the other hand is different again due to that 2003 correction.

    Whatever happens Andy it will be interesting.

  31. Before you report the median price falling, I would consider deleting this blog post.

    Also, is it a FACT that people who own property are wealthier than those who don't? Ev

  32. Why would I delete this post Anonymous? If it is reported that medians have fallen, we can simply assume that the market has actually fallen even further than the reported amount.

    Regarding the fact that people who own property are wealthier than those who don't – after the biggest property boom in Australia’s history, I’d be very surprised if that wasn’t the case.

    Having said that, I’m sure that fact would also hold true in normal circumstances. But thinking about cause and effect, you have to ask yourself – did those people become wealthy by owning property, or did they gain wealth from other sources and put their money into property?

  33. I'm not sure I follow you Peter.

    When will 2 increase solidy and 3 fall solidly to equal 4, leading to 5? And how far should we expect 5 to go? I know what I paid for my house 11 years ago, I know what the current market value roughly is. To buy the exact same little house again today would see us parting with over half our income as an average earning household. How much of the average household income can we really expect people to part with in monthly mortgage payments in the future? 60%? 70%? 80%?

    I understand that many people have been prepared to pay far, far more than I do for home ownership but I'm having difficulty seeing where the broad income growth is going to come from to finance a renewed boom in prices to ever dizzier heights.

  34. Peter Fraser21/3/11 11:45 PM

    Lefty - (2) increases after wage rises.

    (3) will follow an event that will probably occur outside Australia, and could come in late 2012 when the banks have passed their peak interest cost.

    A correction in house prices (1) also affects percentage yields (2) and all of that produces scenario (4) and result (5)

    This is starting to sound like a military manouvre. Have I confused you yet?

  35. http://aussiebubble.blogspot.com/

    Thanks for the inspiration.

  36. Anon:

    I would hardly think Manhatten is representative of New York City ... there are 5 buroughs (from memory), of which Manhatten is only one, and happens to also be the most expensive (by far).

    New York City - as a whole - is certainly known to be the USA's most expensive city, but i'll bet that as a whole it is still a dam site cheaper than Sydney is!

    Compare apples with apples mate!!

  37. Nice looking blog anonymous - glad I inspired you.

    I agree with JB. What’s more, I’ve never actually heard of the first myth that you're try to bust - that Sydney is more expensive than Manhattan. Do you have a link to an article that mentions this?

  38. Peter Fraser23/3/11 6:56 PM

    Sydney should not be compared with the largest city in the most affluent nation on earth.

    Compare Sydney with San Francisco if you want something that is a fair comparison.

    It's been very quiet Andy, although Mufti Nick (the fruitloop)still thinks the world is headed for WW3, and DC the unemployed dropout spends his waking hours (after 11.00 AM) researching deadbeat links looking for the most negative news and whacky theories he can find.

    I hope that interplanetory craft arrives for them soon.

  39. Hi PF - are you saying that it's been quiet here or on forums in general. Sounds like you're missing the banter with the Money Morning refugees??

    I wish I could post and comments more, but I've been really busy with other things.

    You might recall I posted my definition of a bubble on Money Morning about 6 months ago? I plan to refine that and re-post it here very soon.

  40. Anonymous, are you planning on publishing comments on your blog? I tried posting this morning but it hasn’t yet appeared.

  41. Peter Fraser23/3/11 9:52 PM

    Hi Andy - yes it has been boring on most blogs lately. Everything is going more or less as i expected although I'm sure we will get thrown some more tsunamis of some description. It's the unexpected that creates excitement.

    Things seemed to have normalised on MM as well, which is good after a period of quite terrible behaviour by some. I don't know who the rat was but I suspect that he knows me from another blog. I'm not sure about TRB though, I don't know where he is from, but I owe them and you a thanks for the support from time to time.

    I don't immediately recall your definition of a bubble, but probably when I see it again my memory will be jogged.

    Yes post it again here and we can debate it.


  42. Anon

    I'm disappointed in you... no retort??

  43. Andy - I'm starting to think that Nick has flipped out -


    What is your take.

  44. PF

    I see you're still a secret admirer ...

  45. Peter Fraser25/3/11 9:20 AM

    JB - I love good comedy, but they are losing their inane edge. DC just sits there posting link after link, and now mufti Nick is doing the same.

    Can you ask them to go back to the fruitloop posts they are famous for. What about another thread on my sock puppets (you can be my puppet if you like) or what about some wacky alien stories, Nick sees little green men all of the time.

    You can tell them that I am thoroughly disappointed in them, lately they have seemed almost bland, and that isn't good enough.

    I need my fix of daily way out on the edge stupidity, and now they are letting me down.

    it's just not good enough, and if they don't lift their game I'll be complaining to the management. I've got a book to write on paranoid fringe dwellers who think that everything is falling apart around them, and they are the worlds last hope for salvation. So you can see my dilema, I NEED their material, because normal people just can't extend their lunatic inner self enough to emulate Nicks and DC's level of stupidity.

    Can you please ask them to lift their game..

  46. Nick does seem to be having a nice conversation over there with himself. Anyway, let’s keep this blog reserved for property discussion. Speaking of which, has anyone else tried commenting on Anon’s new property blog? He’s let one of my comments through but not another two. Bit unfair after I let him criticise every one of my posts. Or maybe his moderation process is just a bit slow?

  47. Andy

    I think he's trying to protect his blog from your comments - which would make him look stupid.

    Although he succeeds in that without any help from you or anybody else

  48. Peter Fraser25/3/11 10:28 AM

    Andy - I won't be going to Anons blog. I have extended myself to too many blog sites as it is, and I intend to cut down, I just don't have enough time.

    It's getting very repetitious as well, same subjects on every blog.

  49. PF

    i agree with you.
    same idiots making the same kind of stupid arguments...
    in the end who cares what they think - their views aren't going to make one small bit of difference on what the market will do.

    in the meantime i'll be sipping me pina coladas watching the circus around me

  50. JB - for once we are in agreement. I think we blog mainly to test our own views as much as any other reason.

    It's interesting to hear other views, especially if the are well written and make sense, but each of us has very little influence. So few people read these blogs.

    A little early for alcohol for me, but enjoy the pina colada.

    I changed my website link just for you.

  51. lol - good one PF! ;p


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