Tuesday, October 15, 2013

A Common Misconception about the CPI & OER

There is a tendency, well, everywhere, to throw numbers in the face of friend and foe alike, generally in an attempt to produce that silent, “man, you-are-totally-right-and-I-will-never-doubt-you-again” response. Not that it actually happens anyhow. What I’m saying is that numbers tend to demand respect without being qualified. And any chance I can aid in adding clarity to a figure or concept is always a fair excuse to elaborate:

The Consumer Price Index, or CPI, is one of the most loaded figures invented by man. The paradox here is that peoples’ past consumption decisions determine the metric’s current output (demand pull or cost push), and based on that output, people have a tendency to change their future decisions because of it. Or we can just call it what it is: past behavior is a predictor of future behavior.

Visually illustrated:

Distinction is the reason one studies philosophy:

There are two separate housing-components within the CPI index—the common conception of what it is, and the ‘Owners Equivalent Rent’ (OER).

The dirty secret here is that the CPI does not track home prices per se, because the OER concept is really just a proxy.

This portion that makes up nearly one-fourth of the index value is an answer to the question: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?You should be asking your agent this question so you have a better idea at arriving at the appropriate negotiation value for your home (future blog to elaborate).

I want to make one more argument. See the following chart:

Major premise: The Home Price Index (HPI) is the nominally appraised market value of a property. This is what willing buyers and sellers agree upon. Nationally speaking, this is what drives the perception of the “housing market.”

Minor premise: The Owners’ Equivalent Rent, which we acknowledge has limitations, represents the rent-demand pricing power built within an existing home. The increase in home qualification standards, supply constraints, and the change in existing home owner behavior has justifiably increased the fundamental case to establish a floor price on home values.

Argument: the OER specific to one’s region is the qualification number to the CPI. This is the equivalent of the earnings power rising for a company over time. As long as the OER shows strength over time, and it has, then the nominal price of a home will eventually reflect that intrinsic value.