September 8, 2009
Measuring the average selling price of single-family homes in the United States to determine whether they are rising, falling or holding steady should be an easy task for any CPA, right? Just adding up the prices and dividing by the number of sales to get the average each month is as simple as can be, right?
Recent news reports indicate that the single-family housing market is recovering. Is this true? Or did the recovery begin months ago? Or is the recovery yet to begin? Unfortunately, the answer is not simple. This article explains enough about the real estate market to for you to be able to evaluate data correctly.
Before starting, here are some questions you should pose:
The cause of confusion is that the real estate market is not unified. It is a collection of a great number of submarkets, with prices and activity that can travel in different directions.
Housing Price Indexes
A number of indexes that measure housing prices have been used. Some have a long history; others are relatively new. Major ones are described by Dr. James A. Gaines, real estate economist with the Real Estate Center at Texas A&M University (see When Data Collide, Tierra Grande, July 2009).
The indexes considered are: local realtor associations, NAR, FHFA HPI, FHFA P‑O, S&P/Case‑Shiller, Census Bureau, Census Bureau Constant Quality Index, FHLMC CMHPI and First American Core Logic Home Price Index. For each of these, Gaines summarizes variables considered (or not), including:
Widely Followed Index
One of the more recently developed indexes, now widely disseminated by the media and watched by analysts, attempted to pull off a feat that others previously thought of but dismissed as too difficult: the sale and resale of the same house. They try to find sales and resales of exactly the same house. When they do, they try to isolate the price change, arguing that this is the purest way to measure price change.
At least in theory, this should remove the influence of the trend toward larger houses. But can it remove the issue of building onto an existing house? Can it remove the influence of intangibles, such as a one- or two-year builder warranty and a purchaser’s opportunity to select paint and carpet colors or grades of materials? Can it remove the influence of a resale as a distress sale?
Prices and Volume
If both the volume of sales and prices are rising, it sounds like a bull market. But average prices can rise when a greater proportion of higher-priced houses sell than before, while the total volume declines because lower-priced houses don’t sell as well. Accordingly, higher average prices could imply that the upper market stratum is stronger, not necessarily translating into a stronger overall market. Likewise, if financing becomes available for lower-priced houses but not for jumbo loans (generally over $417,000), the opposite can occur.
Seasonality and Inflation
Suppose exactly the same number of houses was sold last month, at the same prices, as the previous month. Does that mean that the market is level? Strangely, the answer is “no.”
Housing prices vary each month, especially with the season. The highest prices and activity are recorded in the summer months, the lowest in winter. This primarily reflects the influence of the school schedule, with parents reluctant to move their children in the middle of a school year. Holidays and the weather are also contributing forces. So level prices from month to month don’t mean a level market.
Many sales reports from multiple listing services (MLS) are only of existing single-family houses and many indexes reflect them only. Often, sales of new homes and of condos can be obtained from other data sources.
Builder-sold houses often included choices to buyers that existing home sellers can’t match, such as choices of colors and quality levels, plus a warranty. Condo sales can vary greatly. Are reported sales only sales to users or do they include investors or speculators buying multiple units with a minimum down payment? Conversions and used condos may not have the features of new construction.
Sometimes a metropolitan area or a region provides a limited perspective. Detroit has joined Las Vegas, Phoenix, California and Florida as being depressed. But those cities or states don’t represent the nation as a whole.
If the market segment for houses in the $300,000 to $400,000 price range in Mobile, Ala., is strong, does that imply that that price range is strong everywhere? That price range represents a high market segment in Mobile but would buy only a shack in San Francisco. Market price segmentation will have different results geographically.
When bank-owned distress sales dominate the market, it is difficult to argue for their exclusion from an index. Bank or lender ownership connotes a forced sale with a much deeper discount than would be acceptable to an individual homeowner who is not forced to sell. Does a sale and resale of the same house reflect its price change when the first sale was by a builder who offered a warranty to the buyer and the resale was an “as is” handyman’s special from a bank forced to dump? For a fair comparison, intangibles included in the sale must be matched just as the size of the house must be matched for a like-to-like comparison.
Investigate the Index
When reports of a housing recovery are in the headlines, check the index, its composition and the benchmarks for comparison. After careful analysis, you may find that the recovery began months ago or has not yet begun, depending on which geographical market and price segment you are interested in. This will put you in a better position to respond to questions posed by your clients who serve the residential real estate market.
Jack P. Friedman, CPA, ABV, CFF, PhD, is a real estate author, appraiser and economist in Dallas, Texas. He is a state-certified appraiser, with ASA, MAI and CRE designations. Contact him at www.realexperts.com.