Some Body Gets it! What's Wrong with American Housing?

This is a "must read" for everyone in real estate, including brokers, appraisers, lenders, and yes even homeowners. It is not a direct condemnation of the appraisal institute/appraisal foundation, mai, but is illustrative of how there inane practices-the use of non-arm's length transaction as sale comparables-have extirpated the downward move in real estate prices. One thing important to note is that when the author speaks of "normal" sales or prices is what we in the industry call "Market" sales or prices. All italicized items are comments from Curtis D. Harris, BS, CGREA, REB FROM: "Anthony DownsThe Brookings InstitutionWhat’s Wrong with American Housing? the Appraisal Institute/Appraisal Foundation, MAI. Foreclosures Are Suppressing Any Major Recovery in Housing ConstructionSales of foreclosed dwellings have increased greatly since 2006, from about 400,000 to almost two million in2010. Foreclosure sales comprised a large percentage of all home sales in 2010, and will do so again in 2011. Itis difficult to determine exactly how many foreclosed homes have been sold monthly during any of the years from2006 through April 2011. Realty Trac estimates that total housing foreclosure filings in each year were as shownin the accompanying table “Calculating Normal and Foreclosure Sales and Prices, 2006-2010.” It usually takesconsiderable time for each filing to result in seizure of the home by lenders and subsequent sales to buyers.Roughly 25 percent of filings in any year result in foreclosure sales within that year; another 35 percent occur assales in the following year; the remainder are settled in some other way. The National Association of Realtors (NAR) publishes the number of homes sold each year and estimates theirmedian prices. By subtracting the number of foreclosure sales from total sales, one can estimate the number ofhomes sold that were not foreclosed. Realty Trac estimates the number of foreclosure filings each year and thediscount at which actual foreclosures are sold below “normal” prices. These inputs were used to construct theaccompanying table “Estimating Foreclosure and Normal Home Sales Prices by Trial and Error, MatchingEstimates to NAR Housing Data, With 30% Foreclosure Discount.” This table shows that the percentage of all home sales each year consisting of foreclosure sales rose from 8.53percent in 2006 to 40.2 percent in 2010. This huge increase in the share of all home sales coming fromforeclosures has greatly reduced the average price of all home sales together. Yet none of the three majorhome price indicators explicitly takes into account the influence of the rising share of discountedforeclosure sales upon either the average overall price or the price of normal, non-foreclosed home sales.As a result, all three price measures over-estimate the price declines of non-foreclosed homes. In fact, in2010, as best I can estimate, the sales prices of non-foreclosed homes actually rose slightly at the same time thatthe three most commonly used price measures showed a slight decline in average housing prices (includingforeclosure sales). These factors hugely undermined the willingness of possible home buyers to purchase homes. That offset thedecline in home prices that might otherwise have increased home buying incentives.Three additional factors reinforced the unwillingness of many households to buy a home (reduced demand.) One was the large inventory of unsold homes, constantly replenished by additional home foreclosures. Potential buyers are reluctantto buy if they believe home prices might fall farther. Another factor was competition from speculative investorswho were willing to pay all cash to buy homes – especially foreclosed homes being sold at large discounts. Suchinvestors hoped to rent the homes they bought out and later sell them at a profit after the economy recovered. The Major Measures of U.S. Housing Prices Provide Misleading Information About WhatIs Actually Happening to Such PricesThere are three major sources of information about current housing prices in the United States: the Case-ShillerIndex, the National Association of Realtors (NAR) data, and the Federal Housing Finance Agency (FHFA) Index.The Case-Shiller Index, owned by Standard and Poor’s, is the home price measure most often cited in the media.It uses matched pairs of two sales of the same homes over time to measure price changes accurately, notdistorted by comparing prices of different quality homes. ( Now one must remember, what is the likelihood of a home selling twice within a short period 2006-2010 if there is sufficient equity, as opposed to one which is underwater over that same period of time. I proposed that most of the paired sales used were foreclosure sales, reo sales, or short sales.) However, it gathers data from only 20 major metropolitan areas in the United States, despite the fact that in 2009 the Census Bureau stated that there were 366 metropolitan areas (each with 50,000 or more residents). The 20 metro areas included in the Case-Shiller Index contained 104.9 million residents, or 40.78 percent of the entire U.S. metro population in 2009. Since the total U.S. population was 307.745 million in 2009, Case-Shiller covered only 34.4 percent of the total U.S. population,omitting two-thirds. Moreover, the 20 metro areas in the Case-Shiller Index included most of those that had thelargest home price increases from 2000 to 2006. Hence they showed much greater home price increases from2000 to 2006, and much larger declines from 2006 to 2010, than were true of home sales in the entire nation. Thiscan be seen in the accompanying chart entitled “Comparing Three Home Price Indices, 1989-2008.” It clearlyshows that the Case-Shiller Index rose much faster than the other two from 2000 through June 2006, then fellfaster than the other two through about May 2009. transactions in over fifty metropolitan areas across the nation. From these data, the NAR computes the mediansales price for all these areas combined. However, the NAR price estimate suffers from two problems. First, ituses median prices for each area and for the nation as a whole, rather than average prices. Second, it does notcorrect for shifts in the sample of home types involved in sales during each period—so the median price actuallycomputed for sales in one period can be influenced by a change in the mix of types of homes sold from oneperiod to the next. On the other hand, since NAR uses data from a much larger number of metro areas thanCase-Shiller, errors caused by shifts in the types of homes being sold in each period are in part offset by thelarger sample of actual sales in far more locations. The third index is the Federal Housing Finance Agency’s estimate of home sales prices. Its sample is confined topurchase transactions eligible for financing by Fannie Mae or Freddie Mac. But it also uses data from many moremetro areas, grouped by regions of the country. And it uses the same matched pair analysis as the Case-ShillerIndex to protect from errors caused by changes in the types of homes that are sold in each period. None of these indexes distinguishes between sales of foreclosed homes and sales of “normal” homes notinvolved in foreclosures. But foreclosed homes typically sell at much lower prices than the same homes would ifthey were not foreclosed. Realty Trac estimates that the average foreclosure discount is 20 to 30 percent.Therefore, as the share of foreclosed sales rises in the total number of sales – as has been happening for severalyears – the overall prices based on both types of transactions combined tends to decline, even if the sales pricesof “normal” (that is, non-foreclosed homes) are not falling at all. Based on data from Realty Trac, I estimate thatthe share of foreclosed sales in total home sales has risen from about eight percent in 2006 to over 40 percent in2010. For every 10 percent rise in the share of foreclosed homes in total sales above zero, the price of all salescombined declines by one-tenth of the discounted price of foreclosure sales compared to normal sales. This canbe seen from the accompanying chart entitled “Relation Between Foreclosures and Overall Price Declines.” The chart shows foreclosures are sold at prices 30 percent less than normal sales. Hence for every 10 percent rise inthe share of foreclosure sales, the overall price of all sales will be 3 percent lower than it would be withoutforeclosure sales. Thus, if foreclosure sales reached 40 percent of all sales, the overall price of all sales would bereduced by 12 percent below normal sales (3 percent times 4). The Case-Shiller Index shows that home prices ofall homes sold from the fourth quarter of 2007 to the first quarter of 2008 declined by 12.06 percent. That drop inthe overall price could have been caused by a rise in the share of foreclosed sales in all homes, rather than agenuine decline in actual home prices, including prices of normal (non-foreclosed) homes sold. This assumes thatforeclosed sales are discounted 30 percent below normal sales. One thing to note here is that I believe that Lack of Demand and High Levels of Forclosures are two sides of the coin and therefore bot CRIRICAL to current market conditions. In the final analysis what have we learned is that during any period of time there may be numerious markets, but always two, a Normal/Fair Market, and a Distressed Market, and for sanity and economic reasons they SHOULD NEVER BE PRECEIVED AS ONE OF "BIFORCATED!"Thanks!
Curtis D. Harris, BS, CGREA, REB
Bachelor of Science in Real Estate, CSULA
State Certified General Appraiser
Real Estate Broker
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