The Advantage of the Home Price Index (HPI) in Portfolio Funds

In the world of real estate investing, understanding property values is crucial. Traditionally, this has been achieved through human appraisals and Automated Valuation Models (AVMs). However, the Home Price Index (HPI) offers unique advantages that make it an increasingly popular tool for portfolio funds like Mortgage Backed Securities (MBS) and Mortgage Investment Funds (MIFs). In this blog post, we will delve into the benefits of using the HPI over traditional valuation methods.

Understanding HPI, Human Appraisals, and AVMs

Before we dive into the advantages of the HPI, let’s understand the basics of these three valuation methods:

1. Home Price Index (HPI): An HPI measures the changes in residential housing prices over time. It uses repeat sales or refinancing on the same properties to calculate the index¹.
2. Human Appraisals: An appraiser physically inspects a property and estimates its value based on various factors, including location, condition, and comparable properties².
3. Automated Valuation Models (AVMs): AVMs use mathematical modeling combined with databases of existing properties and transactions to estimate property values³.

Advantages of Using HPI

1. Broad Market Overview: Unlike individual appraisals and AVMs, which provide data on specific properties, an HPI provides a broader overview of housing price trends. This macro-level perspective is particularly useful for MBS and MIFs as it allows investors to understand overall market movements and adjust their strategies accordingly⁴.
2. Reduced Subjectivity: While human appraisals can be influenced by subjective factors and AVMs can vary depending on the specific model used, the HPI is largely objective, based on actual transaction data. This reduces potential bias and provides a more accurate reflection of market conditions⁵.
3. Cost and Time Efficient: Manually appraising properties or running individual AVMs can be costly and time-consuming, especially for large portfolio funds. In contrast, the HPI is a more cost-effective and efficient way to monitor property value trends⁶.
4. Risk Management: The HPI can help MBS and MIFs manage risk more effectively. By tracking housing price trends, investors can identify potential risks (like a housing bubble) early and adjust their portfolios accordingly⁷.
5. Benchmarking Performance: The HPI can serve as a benchmark to assess the performance of MBS and MIFs. By comparing the fund’s returns to the HPI, investors can evaluate whether they’re outperforming the market⁸.

Conclusion

In conclusion, while human appraisals and AVMs have their place in real estate valuation, the HPI offers unique advantages for portfolio funds like MBS and MIFs. By providing a broad, objective, and cost-efficient view of housing price trends, the HPI is an invaluable tool for understanding market movements, managing risk, and benchmarking performance.

Sources:

1. Federal Housing Finance Agency ↩
2. Investopedia ↩
3. CoreLogic
4. National Bureau of Economic Research ↩
5. Federal Reserve Bank of St. Louis
6. Federal Reserve Bank of Atlanta
7. The Journal of Portfolio Management
8. Real Estate Finance Journal