6401.0 - Consumer Price Index, Australia, Dec 2016 Quality Declaration 
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FEATURE ARTICLE: MEASURING PRICE CHANGE OF ATTACHED DWELLINGS IN THE CPI


SUMMARY

This article outlines the concepts, data sources and methods that will be used to price attached dwellings in the Australian Consumer Price Index (CPI). The measurement of price change for attached dwellings will be implemented in the March quarter 2017 issue of the CPI, which is scheduled for release 26 April 2017. For further information on these changes please contact prices.statistics@abs.gov.au.


INTRODUCTION

This feature article examines the measurement of the price change of owner-occupied housing (OOH) in the context of the Australian Consumer Price Index (CPI). The inclusion of attached dwellings(footnote 1) in the CPI is an enhancement to the coverage and measurement for the New dwelling purchase by owner-occupiers series.

The landscape of Australia's housing market has changed considerably over the past five years where there has been a significant shift of building activity towards high density dwellings. A recent RBA Bulletin article noted: "apartments have become an increasingly important contributor to new dwelling construction over recent years" (Shoory 2016). There are a range of reasons for the shift towards high density dwellings: the cost and availability of land; strong population growth in Australia's major capital cities; and an increasing propensity for both owner-occupiers and renters to live closer to where they work and have access to services such as public transport.

Australian Bureau of Statistics (ABS) building activity data shows a significant increase in attached dwelling building activity in Australia over recent years. Figure 1 shows in the five years to the end of the 2015-16 financial year, the value of building activity for attached dwellings in Australia increased by 130 per cent, compared to an increase of 22 per cent in detached houses; while figure 2 shows the contribution of attached dwelling construction to total residential construction has increased significantly. For Australia as a whole, attached dwelling building activity has increased from less than 30 per cent of the total value in 2009, to 45 per cent in more recent times.

Figure 1: Value of building activity, Australia (4 qtr sum)
Graph: Figure 1: Value of building activity, Australia (4 qtr sum)


Figure 2: Contribution of the value of attached dwelling building activity to total residential building activity
Graph: Figure 2: Contribution of the value of attached dwelling ^building activity to total residential building activity



OWNER-OCCUPIED HOUSING IN THE CPI

The measurement of OOH in the CPI is both important and complex. OOH contributes 9.0 per cent to the total CPI: the highest weighted expenditure class (EC) in the Australian CPI. There are many challenges in measuring the price change of OOH, with the CPI international manual stating: "the treatment of owner-occupied housing is arguably the most difficult issue faced by CPI compilers." (ILO 2004, para. 10.4).

The measurement of price change for owner-occupied dwellings should align with the conceptual basis that best satisfies the principal purpose of the CPI. The Australian CPI adopts the acquisitions approach which aligns to the principal purpose of the CPI, that is, being a general measure of household inflation. For OOH this means the CPI measures the cost of net additions of dwellings to the household sector, which includes new dwellings (excluding land) and major improvements. The treatment of OOH under the acquisitions approach requires the separation of the consumption and investment elements of OOH: that is, land is treated as an investment item not a consumable item, and is therefore excluded from measurement in the CPI. Sales of dwellings that take place between households (generally established dwellings) are excluded so that the weights relate only to net additions to the housing stock.

The New dwelling purchase by owner-occupiers EC in the CPI includes the measurement of price change for detached houses. A matched model approach is used where project home builders are surveyed to obtain prices for specific types of homes each period. The types of project homes selected are those most commonly constructed in each capital city. This method ensures pricing to constant quality and enables adjustments to be applied for any changes in quality, such as the inclusion of bonus offers.

A matched model approach is particularly problematic when attempting to measure price change of attached dwellings: this is primarily due to difficulty in pricing to constant quality. Therefore, the measurement of price change for detached houses is currently used as a proxy for attached dwellings. As a result of the recent increase in building activity of attached dwellings, the ABS has developed an approach to directly measure the price change of attached dwellings purchased by owner-occupiers for use in the Australian CPI.


MEASUREMENT OF ATTACHED DWELLINGS IN THE CPI

The matched model approach is used to measure the price change of goods and services throughout the CPI, including for detached houses. This approach aims to obtain prices for the same goods and services each period, where the quality of the goods and services is held constant. However, the measurement of price change in the purchase of attached dwellings by owner-occupiers is particularly challenging due to the heterogeneity of the attached dwelling market. Namely, as the same quality newly built townhouse or apartment is not available each period, there is an inability to price to constant quality. Therefore, the matched model approach is unable to be used for measuring price change of attached dwellings in the New dwelling purchase by owner-occupiers series.

For this reason, the ABS has investigated the use of the component cost approach to measure the price for attached dwellings in the CPI. The component cost approach is based on the principle that the price change for a product is determined by the price change of the components (or inputs) that are used in the production of the product. The Producer Price Index (PPI) international manual explains how the component cost method treats building output as a set of standardised homogeneous components representing subcontracted work-in-place (IMF 2004, para. 10.150).

The component cost approach is adopted in the PPI output series Other residential building construction, where residential building construction projects are priced each period by updating the unit rate of each component while holding the quantity and quality constant. The component values are then aggregated to produce a current period project value for the output of Other residential building construction series. This series is published quarterly in table 17 of Producer Price Indexes, Australia (cat. no. 6427.0).

For the measurement of the price change of attached dwelling purchase by owner-occupiers in the CPI, the ABS will adopt the component cost approach for apartments and units. In this case a quarterly movement for each capital city will be sourced from the PPI output series Other residential building construction. Differences in quarterly movements between the CPI and PPI series will reflect any changes in the margin in the purchase of attached dwellings faced by consumers. This is discussed further in the next section.

For the measurement of price change of semi-detached dwellings purchase by owner-occupiers, such as townhouses, this will continue to source the existing CPI series for detached houses, as their price change more closely resembles that of detached houses rather than large scale apartment construction projects.


MARGINS FOR ATTACHED DWELLINGS

For CPI purposes, the component cost approach captures price change in the cost of constructing an attached dwelling. This includes measuring the price change of both materials and the labour required as part of construction of the building. ABS liaison with the residential construction industry indicates that the cost of the construction for dwellings contributes approximately 75-80 per cent of the price paid by the consumer (excluding the value of land). The remaining 20-25 per cent of the price paid by the consumer is predominantly the builder or property developer margin. This margin covers expenses such as land preparation and overheads, and a return on investment.

When discussing margins for CPI purposes, it is important to understand what constitutes a margin for attached dwellings. The 2008 System of National Accounts defines a margin as the difference between the actual or imputed price realized on a good purchased for resale and the price that would have to be paid by the distributor to replace the good at the time it is sold or otherwise disposed of." (UNSD 2009). More simply, the margin can be thought of as sales minus the cost of goods sold. In the case of attached dwellings, the margin represents the difference between the sales generated from the purchase of dwellings and the costs to develop the land and construct the building.

For CPI purposes, the value of an attached dwelling excluding the value of land and location is required to align to the acquisitions approach mentioned previously. However, there are no such data available separating the value of land or location from the price paid by the consumer(footnote 2) . Equally as difficult to obtain is data on the replacement cost, or cost of goods sold, at the time of sale, particularly given the lag between the sale of the dwelling and the time it takes to construct the dwelling(footnote 3) .

With limited data available to derive a margin, the ABS will monitor property developer margins through regular liaison with the construction industry and contact with data providers to ensure any changes in margins are captured in the attached dwelling series. Previous liaison indicates attempts are made to maintain margins within a narrow target range through varying the level of dwelling features and inclusions as part of the land development and construction process, and altering variable expenses such as their overheads. Confronting with statistics such as the ABS's Residential Property Price Index (cat no. 6416.0) and other available statistics will be used to measure the change in margins in the attached dwelling series.

Depending on appropriate data sources, future work by the ABS will investigate the use of hedonic modelling to measure price change for attached dwellings purchase by owner-occupiers. Hedonics will explore whether the value of land or location can be separated from the sale price in the case of attached dwellings.


WEIGHTS

Data from the ABS's Building Activity Survey (cat. no. 8752.0) was used to derive weights for residential dwellings and classified into three categories: houses, apartments and semi-detached dwellings. Some of the smaller states and territories experience quite varying levels of building activity from year to year, particularly in large scale apartment projects. Therefore, a three year average (2013-2015) of the value of completion data was deemed a sufficient period to ensure a representative level of building activity across the three types of dwellings.

The CPI weights for the New dwelling purchase by owner-occupiers series are required to reflect dwellings purchased for owner-occupier purposes. 2011 ABS Census data was used to estimate the number of new dwellings purchased for investment purposes (this will be updated using the most recent Census data available). The weights derived from the building activity data were then adjusted to remove the estimated number of newly constructed dwellings purchased by investors. This had the effect of lowering the weight for apartments and increasing the weight for houses seen in figure 2, as the former are more likely to be purchased for investment purposes.

Table 1 shows the contribution of each of the dwelling types by capital city. For Australia as a whole, attached dwellings (apartments plus semi-detached) contributes nearly 30 per cent of the value of newly built dwelling purchases by owner-occupiers. Table 1 highlights the differences in the composition of the newly built residential housing market across Australia's capital cities. In Sydney and Melbourne attached dwellings contribute 40 per cent and 34 per cent respectively, while for cities such as Adelaide, Perth and Hobart it is below 15 per cent.

Table 1: OOH weights by dwelling type (per cent)

Houses
Apartments
Semi-detached

Sydney
60.6
30.1
9.3
Melbourne
66.3
20.3
13.4
Brisbane
74.9
15.2
9.9
Adelaide
85.7
5.1
9.2
Perth
88.2
6.3
5.5
Hobart
93.6
4.1
2.3
Darwin
64.5
25.1
10.4
Canberra
62.0
28.6
9.4
Weighted average of eight capital cities
70.8
19.2
10.0




RESULTS

Analysis conducted by the ABS indicates that the price change of attached dwellings has consistently been lower than detached houses since the recent increase of building activity of attached dwellings. As part of a recent liaison program with builders and property developers conducted by the ABS, there were a range of reasons as to why price change for newly built attached dwellings has been lower compared to detached houses, including:
  • large attached dwelling construction projects allow for greater economies of scale;
  • a greater level of innovation in large attached dwelling construction projects has resulted in improved productivity;
  • large attached dwelling construction projects consist of a higher proportion of imported materials, which have become cheaper relative to domestically produced materials.


CONCLUSION

Over the past five years there has been a significant shift in the level of building activity from detached houses to high density dwellings. There are many reasons for this shift in dwelling composition, in particular the cost of land and a change in consumer preferences.

The measurement of OOH is important to the relevance of the CPI in reflecting the inflation experiences of Australian households. Attached dwellings have become a significant component of new dwelling construction in the majority of Australian capital cities. The inclusion of attached dwellings in the CPI is an enhancement to the coverage and measurement for the New dwelling purchase by owner-occupiers series.

The ABS will continue to assess the method used for measuring the price change of attached dwellings purchased by owner-occupiers and look for enhancements that, in particular, capture price change in the margin faced by consumers.


REFERENCES

Australian Bureau of Statistics (ABS) 1999. Functional Classification of Buildings. cat. no. 1268.0.55.00. ABS, Canberra

Australian Bureau of Statistics (ABS) July 2016. Feature article: Change in Composition of Dwelling Approvals. cat. no. 8731.0, Canberra.

Australian Bureau of Statistics (ABS) June 2016. Feature article: Average Dwelling Completion Times. cat. no. 8752.0, Canberra.

International Labour Organization (ILO) 2004. Consumer Price Index Manual: Theory and practice, International Labour Office, Geneva

International Monetary Fund (IMF) 2004. Producer Price Index Manual: Theory and practice, International Monetary Fund, Washington, D.C.

Shoory, M (2016) The Growth of Apartment Construction in Australia, RBA Bulletin, June.

United Nations Statistics Division (UNSD) 2009, System of National Accounts 2008, New York.

1 The ABS uses the Functional Classification of Buildings, 1999 (cat. no. 1268.0.55.001) to classify residential dwellings into three categories: detached houses; semi-detached, row or terrace houses; and flats, units or apartments. When discussing attached dwellings for this article, it is referring to the latter two categories: where the dwelling is either semi-detached or fully attached to another building. <back
2 The value of location needs to be excluded because, in the case of multi-storey apartments where there is no land associated with the purchase of the dwelling, aspects such as the view from the apartment, or the proximity to amenities or a particular attraction such as the beach will impact on the purchase price. <back
3 Recent analysis by the ABS showed that the average completion times for apartment buildings is approximately 18 months (ABS June 2016). <back