As referred to in Unique Global Estates July 17 Luxury Market Watch Newsletter:
Chicken Little, the Sky Is Not Falling! (Part 1 of 2)
“Real estate prices are plummeting!” “Foreclosures are at an all time high!” “Prices predicted to decline another 20 to 30 percent!”—these are the headlines that we face daily. It’s no wonder that there’s a crisis in consumer confidence. The truth of the matter is that the sky is not falling. In fact, contrary to what the press is reporting, real estate prices are stabilizing, and in a wide number of areas they are actually showing signs of improving.
The S&P/ Case-Shiller index is the gold (scare) standard these days for those who report on the housing market. News agencies began using this index about two years ago rather than the indices provided by OFHEO (the Office of Federal Housing Enterprise Oversight) and NAR. These same news sources often fail to report the numbers provided by major companies such as Realogy.
If each of these resources came to the same conclusion about the market, there would be no issue. The challenge is that NAR, OFHEO, and Realogy all reach the same conclusion: prices are down nationally less than one percent and, in many areas, prices are actually increasing.
In contrast, the most recent numbers from the S&P/Case-Shiller Index (reported on April 29, 2008) reach a very different conclusion:
“Data through February 2008…show declines in the prices of existing single family homes across the United States…The 10-City Composite posted a new record low annual decline of 13.6 percent and the 20-City Composite recorded an annual decline of 12.7 percent.”
“There is no sign of a bottom in the numbers,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Prices of single family homes continue to drop across the nation. All 20 metro areas were in the red for February-over-January reading. In addition, 19 of 20 MSAs (Metropolitan Statistical Areas) are reporting negative annual returns. The monthly data show that every one of the MSAs has now declined every month since September 2007, marking six consecutive months.”
Now compare these numbers to those reported on April 22, 2008 by OFHEO. The OFHEO “Monthly Price Change Estimates for the U.S. and Census Divisions from January 2008 to February 2008” drew the following conclusions:
1. Overall U.S. prices were UP 0.6 percent.
2. Regions reporting increases include the Pacific (0.3 percent), West North Central (1.3 percent), West South Central (0.7 percent), East North Central (1.6 percent), East South Central (1.2 percent), New England (2.2 percent), and Middle Atlantic (0.1 percent.)
3. Only two regions reported declines (Mountain -0.6 percent) and South Atlantic (-0.2 percent).
In other words, a whopping 77 percent of the areas in the U.S. reported a price increase in January 08 – February 08! The S&P/Case-Shiller Index, in contrast, concludes that 95 percent of the MSA’s reported negative returns. Of course, there’s no mystery as to which of these two reports have been in the press.
What accounts for this difference? Both the S&P/Case-Shiller Index and the OFHEO index use “repeat valuations.” In other words, to be included in the calculations, a property must sell twice. The difference in the two sets of sales prices is the basis for each index. OFHEO’s sales price data only includes homes that have conforming mortgages. The Case-Shiller Index covers property sales with both conforming and jumbo mortgages.
Andrew Leventis (June, 2007) attributes part of the difference to the fact that OFHEO “does not lend additional weight to more expensive homes; each pair of home valuations is given equal weight in the index estimation, regardless of the price level of the home.” In contrast, Case-Shiller applies a “weighting” formula before it calculates it data. The challenge with making decisions about how to “weight” certain factors introduces human judgment into the equation and dramatically increases the probability for creating errors.
NAR and Realogy, using a different approach from OFHEO and S&P/Case-Shiller, arrive at essentially the same conclusion as OFHEO, i.e. that the average price of homes in the U.S. was down less than one percent. Their approach is to total up of all the sales, divide by the number of units, and then calculate the arithmetic average (mean) as well as the median. In stark contrast to the S&P/Case-Shiller approach, the technique that NAR and Realogy use includes all properties and is more objective.
From a scientific point of view, when two sets of data produce conflicting results, you look to other sources and/or methodologies to see which data set is supported. In this case, the NAR and Realogy data supports the OFHEO data. It’s the S&P/Case-Shiller index that lacks corroboration from other sources.
Unfortunately, the press almost universally quotes the S&P/Case-Shiller Index and yet, it may be the least accurate housing price index. Next week’s column explains why.
Chicken Little—the Sky Is Not Falling! (Part 2 of 2)
The Case Shiller index portrays itself as being “the leading measure of U.S. Home prices” (Standard & Poor’s Press Release, April 24, 2008). Given how much press the index receives, it may very well be the leader—the leader in inaccuracy.
Last week’s article looked at the contradictory data from OFHEO (the Office of Federal Housing Enterprise Oversight), NAR, and Realogy vs. the S&P/Case-Shiller Index. This week, we look at additional pitfalls that explain why the press should not rely exclusively on the S&P/Case-Shiller data.
1. Where’s the beef?
The S&P/Case-Shiller Index ignores huge chunks of data. Andrew Leventis (2007) in a paper comparing the OFHEO approach vs. S&P/Case-Shiller approach explained the differences in the data in the following way:
“According to the methodology materials, the S&P/Case-Shiller index does not include price data from 13 states. Market conditions in those thirteen states have, on average, been stronger than in the rest of the nation. OFHEO’s estimates indicate, for example, that three of the five fastest appreciating states in the nation (Idaho, Montana, and Wyoming) do not have representation in the S&P/Case-Shiller index…The S&P/Case-Shiller index also apparently has incomplete coverage in 29 states.”
I have to wonder how the public would feel about the “national numbers” that include no data for 26 percent of the states and only partial data for another 58 percent.
2. A bogus claim
The S&P/Case-Shiller index claims to have “100 percent coverage” in nine states. The claim of “100 percent coverage” is false. In the description of their methodology they plainly state:
“The S&P/Case-Shiller indices do not sample sale prices associated with new construction, condominiums, co-ops/apartments, multi-family dwellings, or other properties that cannot be identified as single family.”
The most extreme example of this lack of coverage and how critical is to correctly assessing the market comes from New York City. The S&P/Case-Shiller index claims that prices fell 5.6 percent during the first quarter of 2008. According to David M. Michonski, Chairman and CEO of Coldwell Banker Hunt Kennedy in New York City,
“Condominiums and coops account for 1/3 of New York City sales and 99 percent of Manhattan sales. Thus, Shiller gives the impression of reporting that prices have dropped 5.6% in a place where he does not cover 99% of the sales and where prices have not dropped but risen, substantially.”
Michonski’s claim is based upon data from Miller Samuel, a highly respected appraiser who tracks New York prices. In a summary of activity in the first quarter of 2008, Samuel reports:
“The median sales price of a Manhattan apartment was $945,276, up 13.2 percent from the prior year quarter median sales price of $825,000 and up 11.2 percent from the prior quarter median sales price of $850,000…Average price per square foot was a record $1,289 this quarter, up 20.5 percent from the prior year quarter result of $1,070 and up 9.2 percent from the prior quarter average price per square foot of $1,180... The 10.8 percent increase in year over year quarterly median sales price is the highest increase since the third quarter of 2006 when the increase was 12.7 percent.”
3. Buyers and Sellers Make “Mispricing Decisions”
According to the S&P/Case-Shiller pricing methodology:
“It is also assumed that two sale prices that make up a sale pair are imprecise, because of mispricing decisions made by homebuyers and sellers at the time of a transaction. Mispricing variance occurs because buyers and sellers have imperfect information about the value of a property. Housing is a completely heterogeneous product whose value is determined by hundreds of factors specific to individual homes…The difficulty in assigning value to each of these attributes, especially when buyers and sellers may not have complete information about each factor, means that there is significant variation in sale prices, even for the homes that appear to be very similar.”
How does the S&P/Case-Shiller approach address this challenge? They use a mathematical “weighting formula.” Yes, you read that correctly. The S&P/Case-Shiller approach asks us to believe that buyers and sellers who have actually seen the houses and the neighborhoods are less accurate in their ability to price property than the mathematical formulas from Wall Street and academia. This is absurd. Lenders don’t look to computer generated models to make lending decisions; instead they rely on those buyer and seller “mispricing decisions” (i.e. comparable sales) to determine how much they will loan on a given property.
4. Hedge your bet
Hedge funds use the S&P/Case-Shiller index to allow investors to sell real estate “short.” In other words, if you “hedge” a real estate investment, you are paid when the index declines in value. On the other hand, when prices increase, how much demand will there be for a financial instrument that reimburses you when property values decline?
Ultimately, the question is whom should you believe—the academicians and Wall Street with their complex derivatives that gave us the subprime mess or NAR, the Federal Government, and the real world numbers from publicly traded real estate companies? I know whom I trust—how about you?
Her contact information:
Bernice Ross, Ph.D. MCC
Bernice@RealEstateCoach.com
(512) 263-2985
www.realestatecoach.com
