Measuring owner-occupied housing in the Consumer Price Index

The CPI measures the change in the cost of a 'basket' of goods and services typically purchased by Australian households. One of the most important components in the CPI basket is shelter, whether it is owner-occupied or rented. The change in the price of shelter can have a significant impact on measured CPI inflation and the cost-of-living experience of Australian households. 

The inclusion of shelter for dwellings that are owner-occupied in the CPI is not straight forward due to conceptual and measurement challenges. In comparison, the inclusion of shelter for dwellings that are rented is relatively simple to measure in the CPI and is based on the weekly or monthly amount of rent paid by the tenant.

One of the challenges to measuring owner-occupied housing (OOH) is how the dwelling is purchased, which is typically with a mortgage, unlike most goods and services, which are purchased outright by the household. Dwellings are also a combination of an asset, that being the land component, and a consumption good, being the dwelling structure. Land and other financial assets, like shares and bonds, are considered to be investments and excluded from the CPI.

There are a number of approaches to measuring OOH in the CPI, which are outlined in the International Monetary Fund’s (IMF) Consumer Price Index Manual, 2020 – Concepts and Methods. The CPI international manual defines owner-occupied housing as “dwellings owned by the households that live in them. The dwellings are fixed assets that their owners use to produce housing services for their own consumption, these services being usually included within the scope of the CPI.”

The principal purpose of the CPI is an important consideration in determining how owner-occupied housing is measured in the CPI. In Australia, the CPI is a general measure of inflation used to inform monetary policy decisions by the Reserve Bank of Australia and fiscal policy decisions by governments in responding to inflation faced by Australian households. For shelter that is owner-occupied, the ABS measures the change in the cost of construction of new dwellings, which includes building materials, labour and builder margins. This is one of a number of approaches available to measuring owner-occupied housing that are used around the world by different countries when producing their CPI. The ABS also uses different approaches in the CPI and Selected Living Costs Indexes. 

This article explains the different approaches to measuring owner-occupied housing in the CPI, the approach used by the ABS and how the measurement of owner-occupied housing can impact the level of inflation. The article also provides details on how other countries measure owner-occupied housing in their CPI.

The method used for OOH is an important factor in measuring the CPI. Defining OOH in the context of CPI measurement is not straight forward due to the conceptual and measurement challenges. In selecting the most appropriate approach to measuring OOH, the CPI International Manual states:

"Ideally, the approach chosen should align with the conceptual basis that best satisfies the main use of the CPI. However, the data requirements may be such that it is not feasible to adopt the preferred treatment. Also, the dual use of CPIs as both macroeconomic indicators and for indexation purposes can lead to clear tensions in designing an appropriate treatment for owner-occupied housing services costs that suits all needs."[1]

International standards provide four common approaches to measuring OOH in the CPI:

1. Net acquisitions: this approach treats a house as the purchase of a good that is part asset (the land) and part consumable (the structure) with the price of land being excluded from the CPI. As a result, this method includes new dwelling purchases by the household sector (excluding land prices), alterations and additions, transaction costs, such as tax and legal fees, and running costs, such as repairs, maintenance, and insurance. Existing dwellings are excluded from the CPI as these are typically purchased and sold within the household sector. Net acquisitions is the approach used in the Australian CPI.
2. Rental equivalence: this approach measures the notional price that an owner-occupier would pay if they were renting their own dwelling. This uses the rent paid for an equivalent dwelling in the private sector as a proxy for the costs faced by an owner-occupier.
3. User cost: this approach aims to measure the change in the cost to owner-occupiers of using their dwelling. This treats housing as a capital good that provides services to measure the costs of owning the house. It includes actual expenses incurred such as repairs, maintenance, property taxes, stamp duty and the costs of financing the purchase of the property. The User cost approach also includes depreciation and capital gains, which are difficult to measure in practice.
4. Payments (or Outlays): this approach is similar to the User cost approach but aims to measure the change in the actual payments incurred by households in relation to the purchase of dwellings and ongoing costs. This includes mortgage interest component payments, transaction costs (stamp duty, estate agency fees and conveyancing) and running costs (such as repairs, maintenance, and insurance). This is the approach used in the ABS’s Selected Living Cost Indexes.

In Australia, the principal purpose of the CPI is as a general measure of inflation. The method that most closely aligns to this purpose is the Net acquisitions approach for measuring OOH and has been used by the ABS since 1998.

The advantage of the Net acquisitions approach is that it attempts to measure the transaction price of the dwelling, where the price reflects changes in the cost of building materials, labour and builder margins. This is consistent with the approach used for other durable goods such as motor vehicles and furniture. A challenge with this approach is separating the value of the structure and the land, with the land being considered an asset and out of scope of the CPI. The ABS excludes the value of land by collecting prices on project homes for houses and measuring the cost of construction for apartments. A criticism of the Net acquisitions approach is that, by excluding the cost of the land, it is not capturing the experience of households, where land is an inescapable cost of owning your own dwelling.

The Rental equivalence approach is simple to apply in practice, however, it has the disadvantage of being an imputed price. With the concept being an owner-occupier renting the dwelling to themselves, there is no actual transaction occurring, so an imputed price is needed to measure price change. The rental equivalence approach simply values the services provided from owning a dwelling by the corresponding market rental value of a similar dwelling.

The Payments approach, and to a lesser extent, the User cost approach, are largely impacted by changes in mortgage interest rates. This is how a majority of households purchase their dwelling and is an intuitive way to think about the cost of owning a dwelling. A disadvantage is that for countries that have inflation targeting, an increase in interest rates has a direct upward impact on the CPI, when the purpose of higher interest rates is to lower inflation. This circular feature makes it difficult for central banks to use the CPI as their inflation target when the Payments or User cost approach is used to measure OOH.

The Living Cost Indexes were introduced by the ABS in recognition that no single index could adequately fulfill all identified uses. Additionally, there is widespread interest in the extent to which the impact of price change varies across different groups in the community.

The CPI is designed as a measure of price inflation for the household sector as a whole. The CPI differs in important ways from the living cost measures. The Selected Living Cost Indexes produced by the ABS reflect changes over time in the purchasing power of the after-tax incomes of different types of households. The Living Cost Indexes are similar to the CPI, but differ in two important ways:

1. The Living Costs Indexes are produced for four different types of households based on the primary source of income. Each household has its own distinct basket (weights) that represents the average spending for that type of household. The four households are: employee; age pensioner; other government transfer recipients; and self-funded retirees.
2. The CPI is measured using the Net acquisitions approach while the Living Cost Indexes use the Payments approach. The Net acquisitions approach measures price change for all those consumer goods and services actually acquired by households during the base period. The Payments (or Outlays) approach measures changes in the actual amounts paid (or outlayed) by households to maintain a certain standard of living. The biggest difference between the two approaches is the measurement of OOH costs. The Living Cost Indexes include mortgage interest charges as a measure of OOH, whereas the CPI includes the cost of building a new dwelling.

The exclusion of mortgage interest charges from the CPI and the introduction of the Living Cost Indexes followed a major review of the CPI conducted in 1997 (see Outcome of The 13th Series Australian CPI Review, 1997). The review found that the CPI needed to change from being a measure of the changing living costs of wage and salary earner households to a measure of price change for the whole household sector. This reflected a change in the primary use of the CPI away from being a key input into centralised wage setting processes to being used for monetary policy purposes and inflation targeting. 

If the CPI basket had continued to include mortgage interest charges, it would introduce a circularity between the CPI and monetary policy decisions. This is where an increase in the cash rate by the Reserve Bank of Australia (RBA) leads to an increase in mortgage interest rates. This would then have a direct upward impact on the CPI, when the purpose of a higher cash rate is to lower inflation. This circular feature would make the CPI unsuitable for the RBA to use as its inflation target. 

Another important use for indexes is to enable payments made by governments to pensioners and other households to be adjusted to account for changes in living costs.  In Australia, the Age Pension is indexed twice a year by the greater of the increase in the CPI or Pensioner and Beneficiary Living Cost Index over a six-month period.

Australia’s use of the Net acquisitions approach to measuring OOH in the CPI is impacted by the cost of dwelling construction, which includes the cost of both materials and labour. In 2021 and 2022 the CPI New dwellings series rose in line with the Producer Price Index (PPI) measure of ‘Inputs to house construction’, which measures the cost of building materials.[2] More recently, building material costs as measured in the PPI rose by 1 per cent in the 12 months to June 2024, compared to CPI new dwelling inflation of around 5 per cent. This shows the higher costs of construction has shifted from initially being impacted by material costs to being more impacted by labour costs over the past 12 months.

If Australia were to use the Rental equivalence approach, the increase in OOH would have looked closer to the CPI Rents series, whereas a Payments or User cost approach would look similar to the Mortgage interest charges series used in the ABS’s Selected Living Cost Indexes.

The use of the Rental equivalence approach would have lowered CPI inflation in 2021 and 2022 due to rents increasing by less than dwelling construction costs. This dynamic has switched in the past 12 months, which has seen inflation higher for Rents than New dwellings in the CPI.

The Payments approach and the inclusion of mortgage interest charges would have lowered CPI inflation up until June 2022 due to lower interest rates. The Mortgage interest series has increased significantly since interest rates started to rise from mid-2022. The annual movement peaked at 92 per cent in June 2023 and remained relatively high at 26.5 per cent in June 2024.

Graph 1 shows that for the recent period of high inflation, the use of the Net acquisitions approach to measuring OOH was quicker at including the inflationary impact of housing in the CPI. The increase in mortgage interest charges and rents both started later and peaked 6-12 months after the peak in dwelling construction costs. In this instance, the approach used in the CPI was more timely at capturing OOH inflation than other approaches.

The CPI is produced by National Statistical Offices across the world and is generally recognised as the principal measure of inflation experienced by households.

The CPI is routinely used to make comparisons of inflation in different countries. While using the CPI for this purpose is reasonable, there are some important differences in the way the CPI is measured in each country to be aware of when making these comparisons. How the CPI is measured in each country can differ based on geographical and population coverage, product (goods and services) coverage, methods, data sources, and importantly, the principal purpose of the CPI. Many countries produce the CPI for the dual purpose of a macroeconomic measure of inflation to inform monetary policy where inflation targeting is used, and for indexation purposes, where pensions and other government payments are increased in line with the CPI.

The remainder of this article provides a comparison of recent inflationary trends in selected countries, namely New Zealand (NZ), the United States (US), the United Kingdom (UK) and Canada, as well as the European Union (EU). A focus of the article is how owner-occupied housing is measured in the CPI for each country.

Prior to the COVID-19 pandemic, annual CPI inflation in the countries being compared was relatively low and stable, generally tracking below 3 per cent. From 2021, the increase in inflation represents the highest inflation experienced over the past 30 years.

Among the selected countries, graph 2 shows CPI inflation started to pick up first in the US in early 2021. Higher inflation followed in Australia, New Zealand, Canada and the UK over the next six months. While the increase in inflation in Australia may have started later, and been slower to rise, Australia caught up to the other countries, with inflation peaking at the end of 2022 at 7.8 per cent. This was the highest inflation in Australia in 32 years. Over the past 18 months, CPI inflation has steadily fallen in all countries to be less than half the rate it was in 2022. In September 2024, CPI inflation was 2.8 per cent in Australia, which was in line with inflation in the US and UK and above the other countries being compared to in graph 2.

When assessing Australia’s approach to measuring OOH, it’s helpful to compare how other countries measure OOH in their CPI. Australia and New Zealand use the Net acquisitions approach, which aligns to the principal purpose of the CPI as a macroeconomic measure of inflation. Data is available separately on the price of land and the structure, which enables the land component to be excluded due to it being considered an asset rather than consumption. Rental equivalence is used by the UK and US, while Canada has adopted a User cost approach. The EU does not currently capture OOH due to data limitations in many member countries, but there is ongoing work to consider whether a Net acquisitions approach is possible.[3]

Table 1 shows which approach to measuring owner-occupied housing is used by the selected countries.

The choice of approach to measure OOH also determines the weight (contribution) in the CPI. Rental equivalence generally results in a higher weight in the CPI as all households, both new and existing owners, are included in the weight. Net acquisition tends to have the lowest weight as it captures new additions to the housing stock only and does not include existing dwellings. 

Graph 3 shows that the choice of approach to measure OOH has a significant impact on the weight in the CPI. The UK and US have the highest weight, which both using the Rental equivalence approach. In fact, the weight of OOH in the US contributes over one quarter of the CPI basket. Australia and New Zealand both use the Net acquisition approach, which results in a weight for OOH of 8 per cent in Australia and 10 per cent in New Zealand. 

When adding other housing related expenses like actual rents, repairs and maintenance, utilities and property taxes, the weight for Housing in the Australian CPI is 22 per cent of the CPI basket. This compares to a weight of 41 per cent in the US, with the difference due to their respective weights for OOH.

Graph 4 shows the annual percentage change in the OOH component over the past seven years. Prior to 2021, the price change of OOH in each country was similar and relatively low and stable. Over the past three years, there has been a large divergence in the annual movements in the OOH series in each country. In the case of Australia and New Zealand, it has been a significant contributor to CPI inflation with an annual movement peaking at around 20 per cent in 2022 for the OOH series, which was over twice the peak in CPI inflation. While in the UK and US, the increase in OOH was initially lower than overall CPI inflation, but has since risen steadily over the past two years to now be higher than CPI inflation.

The increase from 2021 to 2022 in OOH in Australia and New Zealand was due to higher material costs and strong demand for new dwelling construction. Due to the different methods used to measure OOH, this was not captured in the CPI of the other countries, despite higher global prices for timber, steel, concrete and other construction materials. Since 2023, higher interest rates have led to an increase in OOH inflation in Canada, while rising rents in the UK and US have seen higher OOH inflation in their CPIs.

Graph 4 demonstrates that while attempting to measure OOH, the different approaches can result in very different contributions to CPI inflation. OOH inflation in Australia and New Zealand had an upward contribution on CPI inflation in 2021 and 2022, while for the other countries, OOH inflation was less than overall CPI inflation when it peaked in 2022. It also showed the start and peak of the increase in OOH inflation earlier when compared to the UK and US. The more timely approach used in Australia and New Zealand is an important feature when the CPI is being used as a measure of inflation. 

1. Paragraph 11.83, Consumer Price Index Manual: Concepts and Methods, 2020
2. For more details on construction in the PPI see Insights into Output of Building construction prices
3. See Owner-occupied housing and the harmonised index of consumer prices - Outcome of the work of the European Statistical System - 2023 edition