Do sales prices overstate underlying house prices in market downturns? Evidence from the Canadian house price crash of 1991

Over the last decade there has been a mounting realization that the quality-adjusted price of properties that sell may be quite different from the quality-adjusted price of all properties (Gatzlaff & Haurin, 1998). The difference is apt to be especially marked during downturns. Dependence on price indexes based on transactions data could result in overoptimistic appraisals by mortgage lenders during the early quarters of downturns. This paper provides evidence on this issue by examining the residential real estate crash at the start of the 1990s in Canadian cities, especially Toronto. The plunge in prices estimated here for Toronto is 17%. We estimate the drop in the transactions price using MLS data, which are not quality adjusted, supplemented by Royal LePage data, which are. We estimate the drop in the price of houses in the stock using hedonic indexes based on home owners valuations; outlier observations are cut from the sample on the basis of the DFFITS criterion. The hypothesis of equality of the drop shown by the two measures is strongly rejected, for Toronto, and is also rejected for several other cities.