Basics -Implied HPA using prices

Many housing economists and traders prefer to quote home price changes in terms of HPA (annualized Home Price Appreciation).  For a one-year holding period this is simply the (End Price/Begin Price)-1 expressed in percentage terms.  

For longer periods one must discount the End Price/Begin Price fraction by time, so a three year holding period HPA would be:

((EndPrice/BeginPrice )^.3333) – 1

With that math, with quotes in all  the Nov 2011-2015 expirations, and with the Nov 2010 as the most recent Case-Shiller release, one can easily compute implied HPA for both long-term holding periods (say spot vs. 2015), or for interim periods (say Nov 2013 vs Nov 2014).  The results for mid-price quotes are shown here.

Reading the table one can see that the implied annualized  HPA over the five years from Nov 2010 to Nov 2015 is 1.7% (lower right).  This is a result of a total price increase of 1425 points or 8.8% over five years.

The path to higher prices is not a straight-line.  Prices dip in 2011, and then rebound at ever slightly higher annualized rates (e.g. 2.4% between Nov ’11 and Nov ’12 to 3.9% between Nov ’14 and Nov ’15).

Note that prices shown here are mid-market prices.  Since bids will be lower, the price gains, and therefore annualized HPA will be lower.  Offered prices result in higher implied HPA. (next blog).

A final point (to help trading) is that while one might have a weak view on the level of home prices for a particular year, one might have a strong view on the HPA for any given year.  Spread trading, allows a trader to express such views on particular years.

So, for example, while the difference between Nov ’12 and Nov ’13 mid points is 440 points or 2.8%, someone thinking that home prices will rise more than 2.8% during that period might think the spread should be wider and could enter such a spread trade order. 

(A warning -spreads are quoted backwards from what a layperson might think.    Since the earlier contract is quoted first both in terms of action and price, someone looking for the spread to widen would put in a spread order to sell the front contract at a discount to the back contract.  The more negative the number, the more the person thinks that back contract prices are going to rise -relative to the front contract.  More later, but this is an important qualifier.)