The Link between Credit Growth and Real Estate Bubbles
February 12, 2025
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The real estate sector is deeply intertwined with the overall economy. An increase in the real estate sector causes a corresponding increase in the GDP of a nation. Hence, the decrease is real estate activity also causes economic mayhem. It is for this reason that real estate needs to be monitored carefully by governments. By monitoring the real estate sector, the government can identify issues related to real estate before they become big or important. These issues can then be rectified with the use of fiscal and/or monetary policy. However, the issues need to be identified before such a resolution is reached. Hence, there is a need for a real estate price index.
Ideally, such an index serves as the barometer for the entire market. However, construction of real estate indices is difficult because of very nature of the underlying asset. In this article, we will discuss some of the common difficulties that are faced during the creation of real estate price indices.
The major problem with this method is that it does not consider the fact that properties are heterogeneous. Since all the properties are mixed together the results are inaccurate at best.
For instance, if only the values in urban areas continue to rise whereas the ones in rural areas are falling, the index could still show a positive trend!
The idea is to create micro markets wherein properties with similar characteristics are aggregated. Also, the value of all the properties can be compared to a base year.
For instance, if the value of all the properties in the year 2010 was considered as 100, the index will show the current value in 2018. If the value is 160, then there has been a 60% rise during the eight-year period. The problem with this method is that it requires extensive calculation.
Several econometric formulas are used to arrive at the final index value. It is possible that the index may be skewed due to some vested interests. However, most of the times, the value depicted is fair and accurate.
This method is used in Scandinavian countries, Switzerland, United Kingdom and even India. The National Housing Board Residex Index has been created on similar lines.
The bottom line is that different methods can be used to create real estate indices. The choice is made depending on the availability and accuracy of data. It is also apparent from this article that real estate indices function very differently when compared to other indices.
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