Thought Leadership | Mortgage | How To & Education
Several questions have come across my desk indicating people are confused about the difference between median and average. Median price, for example, is one of the most closely watched data points in real estate and is frequently confused with average sale price. Since medians and averages are two very different housing metrics, in Part 1 of this two-part series, we’ll take a little time to demystify these metrics and explain why home price trends are usually expressed as medians rather than averages. In Part 2, we’ll explain the why median is not a perfect metric, either.
The median price is simply the middle value in a group of values. Here’s a simple example: Let’s say in the past month, five houses sell in your neighborhood for these amounts:
House 1 = $235,000
House 2 = $285,000
House 3 = $325,000
House 4 = $385,000
House 5 = $725,000
The median is the middle value: House No.3 at $325,000.
Most people know how to compute an average but let’s review so we’re all on the same page. Using the same example, we add the sales prices of all the homes sold and divide that number by the total number of homes.
So: $235,000 + $285,000 + $325,000 + $385,000 + $725,000 = $1,955,000
Then: $1,955,000 ÷ 5 = $391,000
Why We Use Median Instead of Average
In our example, the average price of homes sold, $391,000, is much higher than the median price of homes sold, $325,000. These metrics differ substantially because a single high-priced home can pull the average price much higher.
The median price, meanwhile, is unaffected by the one high-priced home in the mix, which we call an “outlier.” This is why we prefer median to average in describing home values: because outliers cannot influence the median value.
In real life, the sales prices of the highest volume of homes sold in a neighborhood typically cluster within a certain price range. In California, for example, most homes sell in the $200,000-$500,000 range, with a smattering selling for more than $1million and very few homes selling for more than $10 million.
If you calculate an average price, just a few $10 million home sales can pull the average price much higher than what most homes sell for in California. The median price, on the other hand, is impacted much less by the few very-high-priced homes. The middle value, found in the $350,000-$400,000 price range, yields a metric closer to the actual value of homes sold in California
.…BUT Median Prices Are Not a Perfect Metric Either
We save a discussion of why median prices are not a perfect metric of home values for Part 2 of this blog series. In a rapidly changing price environment, like we have seen in California over the past year, median prices can overstate actual price increases by 50 percent or more, dramatically influencing purchase and/or investment decisions.