Home Sales and Prices: Noise in the Numbers
This week brought a lot of positive news on the home sales front, with contracts signed for existing homes in December up 2 percent month-to-month and sales of newly built homes up over 17 percent month-to-month.
It has a lot of housing watchers confused as to why the other big report of the week, the S&P/Case-Shiller Home Price Index, still showed prices falling.
The bottom line is that reporting home sales is far easier and far more basic than figuring out home prices.
My colleague at CNBC, Jim Cramer, said on his show that the equity markets are relying too heavily on Case Shiller, and he makes a very compelling case as to why they shouldn't. He prefers the government's report from the FHFA (Federal Housing Finance Authority), overseer of Fannie Mae and Freddie Mac. I'm not going to get into all the methodology arguments that have been made over and over again from all sides because that's not going to give investors any answer as to where home prices are going. I will say that investors should take each and every home price report on its particular merits and not give any one more weight than another.
With the housing crash came a huge proliferation in the number of data organizations publishing home price reports: Zillow, CoreLogic, Clear Capital, in addition to the National Association of Realtors, Case Shiller and FHFA.
When considering any of these reports, you have to look at several factors, first and foremost looking at home prices year over year. I know FHFA says they "seasonally adjust" their month to month price numbers, but home prices, as I've said so many times before, are subject to seasonality more than sales. Families needing larger, more expensive homes tend not to move in the middle of the school year. They wait until Spring to secure a contract, so they can move over the summer. That leaves Fall and Winter to buyers without kids or first-time buyers, who tend to buy smaller, less expensive homes.
The second thing to look at is distressed sales. Some of these reports measure sales of foreclosures better than others. With distressed properties making up anywhere from 25-50 percent of all sales in a local market, foreclosure pricing and short sale pricing (when the home is sold for less than the value of the mortgage) is crucial to an overall understanding of where prices are at any given time. Also, remember that most of these reports are taken from numbers in the local multiple listing services or from local court records, so if an investor, say a hedge fund, buys up bulk properties distressed properties, whether from Fannie or Freddie or from a bank's REO (real estate owned, i.e. repossessed by the bank) portfolio, that may not always end up these reports.
Standard and Poors gave me a very helpful explanation of how foreclosures figure into the S&P/Case-Shiller report:
"When a house is foreclosed, there are typically two transactions:
1) Bank repossession of the property,
2) Sale of the bank-owned property.
Transaction (1) is not a candidate to be included in a S&P/Case-Shiller indices, but transaction (2) can be included. [I would note here that this is a big deal because banks, FHA and Fannie and Freddie have huge and growing inventories of foreclosed properties]
Before a bank repossesses a house, it will usually hold an auction on the courthouse steps. In nearly all cases, the minimum bid is at least equal to the outstanding mortgage balance. Since most foreclosed homes have substantial negative equity when they are auctioned, in the vast majority of cases, if there is a bid, it is too low to meet the minimum. After the auction fails, transactions (1) and (2) take place.
But if the auction is successful, this transaction is a candidate to be included in an S&P/Case-Shiller index. Short sales are also candidates to be included in the indices.
So the investor purchases of Freddie and Fannie-owned properties could be included in the indices if they can be paired with a previous arms-length transaction. A successful courthouse auction could also be included."
It's hard to say, though, if big bulk purchases (as in Miami condos) could be compared, property to property with a "previous arms-length transaction." My guess is no. And don't forget many foreclosures are of new construction, where there was no previous owner. Meanwhile, FHFA numbers are taken only from sales of homes with Fannie and Freddie loans, so a lot of higher-priced properties are left out.
Suffice it to say there is currently so much noise in the pricing numbers, thanks to the home buyer tax credit last year that completely and artificially skewed sales, that it's very hard to tell where we are. Home sales appear to be improving slightly, albeit from very low volumes. Home prices always lag sales. They did during the crash as well. Even as sales were falling, prices kept rising (I remember saying over and over on CNBC "these prices are unsustainable," and they were).
Many experts believe that an onslaught of foreclosed properties onto the market, as banks reinstate robo-foreclosures, will put additional downward pressure on home prices in 2011 before price recovery. I tend to believe them. The foreclosure pipelines are huge, and they are an equally huge impediment to price recovery. Sales should rise this Spring, as the economy strengthens and consumer confidence returns, but it will take home prices longer, and as always, the story of pricing will become ever more local.