Journal of Real Estate Finance and Economics, 19:3, 223±241 (1999)
# 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Controlling for Quality in House Price Indices
JEFFREY E. ZABEL
Economics Department, Tufts University, Medford, MA 02155
Given the importance of house prices it is not surprising that house price indices are used for many purposes. One
of the factors that differentiates these indices is the house price determinants (such as structural characteristics
and neighborhood quality) that are accounted forÐthat is, held constant. Indices are usually generated from house
price regressions. It is shown that, regardless of the desired level of accounting, it is necessary to control for all
signi®cant determinants of house prices in these regressions to obtain unbiased estimates of the growth in house
prices. An empirical example shows that not controlling for neighborhood quality can lead to substantial biases in
estimates of house price appreciation rates even if the index does not account for this factor.
Key Words: house price indices, hedonic models, repeat sales, quality control
Housing assets play a major role in the U.S. economy at both the macro and micro levels.
Housing assets are valued in the trillions of dollars, so they clearly are a signi®cant
component of national ®nancial assets. For the individual, the house is the most important
asset held (Megbolugbe, 1995). Thus, there is a lot of interest in the value of the housing
asset and changes in this value over time.
Given this broad concern, it is not surprising that house price indices are used in many
different capacities. At the macro level, interest lies in a national house price index or in
comparisons across regions or metropolitan areas. In these cases, it is important to
compare a standard house across time or space. This will lead to an estimate of the price of
a standard unit of housing that can be used to calculate cost-of-living indices. At the micro
level, if one is interested in a house (or portfolio of houses) for investment purposes, then
one is not so concerned about holding all of the characteristics of the house constant. The
latter use is related to indices that re¯ect changes in the price of a ``representative'' house
whose characteristics may change over time (Pollakowski, 1995; and Wang and Zorn,
These varied used will give rise to different house price indices. One way to
differentiate them is by the level of housing quality that is accounted for (that is, held
constant) in each one. If interest lies in comparing the price of a constant unit of housing
across time or space, then it is important to account for the characteristics of the house. If
the focus is on a ``representative'' house, then accounting for all house characteristics is
not required. Thus, ``constant-quality'' indices will measure changes in prices of different
housing bundles depending on what is actually being held constant. It is important to be
explicit about what is being accounted for when comparing different indices.