Understanding Average Calculation Methods
The National Association of Realtors (NAR) periodically releases a report that provides information and price trend for homes sold. It may say that home prices are down. That may feel a bit confusing, especially if you have recently read that home prices have bottomed out and turned a corner.
In one publication you might read that we are definitely in a “buyer’s market”, with a rapidly growing inventory of homes for sale all over the country. In another news report, you learn that frustrated buyers are being outbid in multiple offer situations time after time and that prices are still moving up.
So why is there such confusion, and a lack of clarity about whether average prices are moving up, down, or may be flattened out? It all depends on what method of calculation is used to determine what “average” means. Some sources base their conclusions on the “mean average price”, others use “median price”, and some go by “average price per square foot”. Some choose to use repeat sales prices and compare over time. Here is how these approaches differ.
The Significance of the Median
When I began my real estate career in the 1980s, the only way “average prices” were calculated was to add up all of the values of homes sold in a particular area and period of time and then divide by the total number of homes sold. That method never felt right to me to use particularly in our market area because it can be heavily influenced by the sale of a few homes at the very high end.
I have felt that the “median average” is more accurate because it is less affected by extremely higher-priced sales. It is also simple to calculate, by arranging the sales in ascending or descending order and then noting the middle price. This means that half of the homes sold for a higher price and half sold for a lower price. If more lower-price homes have sold recently, the median sale price would decline.
Challenges with Other Price Trend Measures
Many people rely on an even simpler measure, “price per square foot”. While that approach is seductively easy to try to use, it can be significantly impacted by various factors such as the neighborhood, sales where the square footage is not reported so it shows as zero, and if there might have been a preponderance of small-size homes essentially sold for lot value.
Still, others like to refer to the “repeat sales index” numbers that Case-Shiller publishes, which involves a calculation of changes in home prices based on sales of the same property at different times. While this method supposedly avoids the problem of having a wide range of differences in homes with varying characteristics, it too has its own significant drawbacks. For example, the house may have had substantial improvements done which were not known by the data collector. Also, in many areas of the country, it would be difficult to find enough repeat home sales to do accurate calculations.
Impact of Rising Interest Rates on Home Affordability and Median Prices
In such unusual times as we have experienced over the last year, rising interest rates have substantially impacted the affordability of homes. This has resulted in a greater number of “less-expensive” homes being sold, which in turn is reflected in a decline in median prices. That does not mean that any specific single house has lost value!
So, when I calculate an estimated range of value for any particular home today, I feel that all of these factors need to be considered. Our team now looks at all of the known variables, looks at the price levels of homes in escrow and homes recently sold, and compares with every home currently for sale in that neighborhood. When the various measures differ, we make every effort to adjust the value range to accommodate each of those averages.
The fact is that the real estate market has significantly changed over the last 12 months. For several years we had seen prices steadily increase, with such strong buyer activity that sale prices averaged about the same as listing price averages. That “seller’s market” is no longer present in most areas and price ranges. Homes recently have been selling for around 5% less than the average list price, and it is taking a bit longer for them to sell. Thus once again it has become more important to accurately calculate what value a home may have in the present market moment.