So Cal Real Estate News

(July 30, 2008)  At 9 A.M. Eastern Standard Time, on the last Tuesday of every month, McGraw-Hill’s Standard & Poor’s Unit releases the  Case-Schiller Home Price Index for the previous month, just like clockwork.

The news media love it:  “Breaking news” on housing they can schedule into their calendar months in advance, just like DataQuick’s monthly median home sales price reports.

Conversely, Case Schiller must love the media. If it’s the last Tuesday of the month, Case-Schiller will on the radio,  be all over the internet, in the networks’ evening news, and in the next day’s paper.

There’s one thing to love about the Case Schiller Home Price Index, and at least two problems.

About Case-Schiller, In S & P’s Own Words:

Let’s start by getting an overview “straight from the horse’s mouth:”

The S&P/Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States.

These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs. This index family consists of 20 regional indices and two composite indices as aggregates of the regions.

The S&P/Case-Shiller Home Price Indices are calculated monthly and published with a two month lag.

Looks like we may have just given away one of those problems, but before we get into that, let’s see exactly how these folks come up with their numbers, again taken from their own website (links at the end of this post).  The key to their method is a tool Karl Case and Robert Schiller came up with back in the 1980’s.  According to S & P:

They developed the repeat sales pricing technique, still considered the most accurate way to measure this asset class. [even if they do say so themselves!] The methodology measures the movement in price of single-family homes in certain regions.

This is done by collecting data on sale prices of specific single-family homes in the region. Each sale price is considered a data point. When a specific home is resold, months or years later, the new sale price is matched to the home’s first sale price.   These two data points are called a “sale pair.” The difference in the sale pair is measured and recorded. All the sales pairs in a region are then aggregated into one index.

Sales pairs are carefully screened for any data points that would distort the index. These factors include foreclosures, non-arms length transactions (sales between family members) and suspected data errors where the order of magnitude of the change is substantially different from other sales pairs in the region.

Once the “sales pairs” have been screened, they are weighted:

The indices are designed to measure the change in the price of homes that have not undergone significant positive or negative changes in quality. Sales pairs are assigned weights to account for fluctuations in price that can be attributed to factors like extensive home remodeling, adding a home addition, or extreme neglect.

For example, the indices assign smaller weights to sales pairs with large change in sales price relative to the community around them. The assumption is that this change is due to remodeling or neglect. Sales pairs are also weighted based on time intervals between sales.  Sales pairs with longer time intervals are given less weight than sales pairs with shorter intervals to account for the probability of physical changes.

In other words, Case-Schiller compares sales of the same property, trying to eliminate sales where changes in value could be influenced by neglect, upgrades or sales between family members

What’s not to like about that?

All indices have strengths and weaknesses.

Problem # 1:  A bigger lag than you think!

One of Case-Schiller’s weaknesses seems pretty obvious:  a two month lag.  However, as the infomercial salesperson says, “but wait, there’s more!” Again, from Case-Schiller themselves:

The monthly indices use a three-month moving average algorithm. Home sales
pairs are accumulated in rolling three-month periods, on which the repeat sales
methodology is applied. The index point for each reporting month is based on
sales pairs found for that month and the preceding two months. For example, the
March 2008 index point is based on repeat sales data for January, February and
March of 2008.

OK, time for a pop quiz.  Exactly when was that “March 2008 index” released?  The last Tuesday in April!

We’re not just looking at a two month lag here–we’re looking at a two-month lag on stats averaged over three months.  Using the middle of that three month range, we’ve got a three and a half month lag, with a five month lag on the oldest stats!

Let’s use a more current example.  I’m writing this on Wednesday morning, July 30, 2008.  Yesterday, July 29, Case-Schiller released their report for May, which was actually a composite of March, April, and May closings.

“But wait, there’s more!”

When did those March, April, and May closings go into escrow?  Here in Southern California, the “average” escrow is about 45 days, although lending problems often stretch that out, especially in the current chaotic mortgage market.  In the current market, it often takes about a week of negotiation before escrow is actually opened.  Some agents wait even longer, until the buyer has a physical inspection completed and repairs negotiated.  So those deals that closed in March, April, and May were actually negotiated during January, February, and March!

Yup, that’s right.  The price drop the media breathlessly hailed yesterday took place on sales that were negotiated five to seven months ago.  Now that’s what I call a lagging index!

Bet you didn’t hear those little details on the news last night!

Other problems:

Case-Schiller tells us they try to “carefully screen” the matched pairs they base their report upon, but a computer can only do so much.  They can spot changes in square footage between sales, but tax records in California rarely reveal anything about most kitchen remodels, let alone “neglect.”   Sales between family members are easy to spot if everyone has the last name, but that’s only the case some of the time.  And what if the last name is as common as Smith, Rodriquez, or Nguyen?

Random note: I just misspelled “Nguyen,” and Firefox’s spell check caught it!  I’m impressed.  If you’re still using Internet Explorer, maybe it’s time for a free download!

Besides an amazingly long lag and probelms in screening the “matched pairs” of sales, other problems  include the use of broad regions. Real estate trends can vary dramatically between adjoining zip codes, school districts, and even condo projects; painting with a broad brush obscures significant details.

Since Case-Schiller reports an index, not actual prices, it gets even harder to interpret.  Does a 23%  drop in the index really indicate a 23% drop in prices?  Does anyone really know what it actually indicates?  If you’re a CPA or statistician, you might want to follow the links at the end of this post deeper into C-S’s explanations and let us know your conclusions with a comment.  In any case, with an “index” we’re an additional step away from actual prices.

Finally, for now at least, Case-Schiller doesn’t tell us anything about sales volume–it just gives us a cryptic but supposedly well though-out index of price.

So What’s to Like About Case-Schiller?

For all its flaws, Case-Shiller is an index that seeks to get beyond averaging medians (see “Two big problems with DataQuick’s monthly median price reports“).  It gives us useful data from a different perspective that can be helpful looking back.  But the time lag makes it problematic for forecasting or even for evaluating forecasts.  It’s hard to figure out what’s going to happen next, when you don’t yet know what’s been happening over the past three months.

So What Do We Make of Case-Schiller’s Latest Numbers?

As one would expect from a lagging index, they tend to confirm what we already know:  Prices were down dramatically earlier this year.  In fact, for the Los Angeles and Orange County regions, home prices last winter were down about 25% from a year earlier.  That’s the crux of yesterday’s C-S report.

The big mistake we see right now is the impression that this is a new, record-breaking drop.  It’s just old news about the record-breaking drop that was occuring in the market last winter, and that DataQuick when they released their their closing data for the spring months. Old news.

C-S’s latest report certainly doesn’t change the opinion of where the market’s headed that we posted last Friday.  Nor does it change our basic recommendations of what potential sellers and buyers should do in uncertain times like these.

Today’s unusual real estate market presents unusual opportunities along with some risks.  For buyers, the risks have been dramatically reduced from a year and a half ago, as Case-Schiller’s most recent numbers document.

For more information:

Link to Case-Schiller’s monthly Home Price Indices

Standard & Poor’s own description of their Case-Schiller index

Making Sausage: S & P’s own description of how the Case-Schiller indices are compiled

Wikipedia entry on the Case-Schiller Index (Not Wikipedia’s best article–disappointing and confusing)

It’s been pretty clear for a while that, in Orange County and Los Angeles County, at least, we passed the bottom for sales activity this past winter.  (”What’s next for Southern California housing?“)

It’s also growing increasingly clear that the bottom for prices is still ahead of us.  (See “Snapshot from the front lines: One bottom, maybe two.”)

But there’s another “bottom” that also recently passed us by.  Unfortunately, that’s the bottom for long term interest rates.

While watching the Dodgers beat the Angels in 100 degree heat on Saturday, Blair and I were discussing some mutual friends he was about to open an escrow with.  They were young teachers (like both Blair and I were once), and wanted to take advantage of some special first time buyer financing that was about to phase out.  Blair had placed another couple in a similar loan about a month earlier, and he remarked how the fixed interest rate on that program had gone up almost 1% in that month.

Now I’ve been aware that long term rates are going up, and warning about the consequences, but it really hit me between the eyes as I was filling up my 12 gallon Element’s tank at Costco yesterday morning:   The roaring return of inflation means long term interest rates aren’t likely to come back down any time soon.

Somewhat like sales volume and prices (see “Predictions 101: Our 2 market cycles“), mortgage interest rates tend to go down in the winter and up in the spring, possibly for the same reasons.  But this spring’s increase in rates is now accelerating due to the return of inflation, especially oil-related inflation.

The main causes of those oil price increases ?

1. Increasing oil demands from China, India, and the developing world.
2. The decline in the U.S. dollar’s value.

Reason #1 is cited as the main cause, and all the evidence is that so far we’re just seeing the tip of the iceberg as young industrial giants continue to grow.  U.S. oil usage is now just an ever-decreasing fraction of usage in these growing new economies.  That’s why we can expect fuel and other commodity inflation to only increase for the immediate and possibly long term.

Reason  #2 was largely caused by the Fed’s cuts in U.S. interest rates.  That further restricts the rate-cutting they’re able to undertake.  More significantly, the Fed only controls short-term rates; long term rates are determined by market conditions.  Those long term rates frequently move in the opposite direction when the fed makes cuts in short term rates.

Bottom line:  Long term mortgage and interest rates will continue rising for most of this year, although they may dip modestly next winter.  Only the onset of a very major recession is likely to reverse the upward trend.

That dramatically affects the cost of housing.  With the mythical 20% down on a $500,000 median OC home, the principal and interest payment on a 30 year fixed loan @ 6% is just under $2,400.  @7% that same loan payment rises over 10% to $2661.

In my 30 years of working with buyers, I’ve found that most view cost in terms of down payment and loan payment more than in terms of sales price.  To bring the loan payment in our example back down to $2,400 the loan amount would have to drop almost 10%.   That’s a 9% price drop if you allow for the reduced down payment to be added to the loan.

At this point most economists think the continuing flood of homes entering the foreclosure process in Orange County, Long Beach, and Los Angeles County ensure continuing price declines throughout the region (see “So Cal April Foreclosure Data Just In“).  Are you ready for another 10% decline on top of that?  Add that to ripple effects of the economic decline that may be just beginning, and the scenario gets downright scary.

Recommendations?

Market timing is nice, but you need to give primary consideration to your personal situation.  (See “What to do when nobody knows what’s next.”)  We believe it’s time to think of a house primarily as a home and primarily as a piggy bank or investment.

Potential Selllers: Before you panic, remember the words of Frank Nothaft, chief economist at Freddie Mac to last fall’s California Realtors’ Expo 2007, as he was discussing how low prices would go and when things would turn around: “We just don’t know,” Nothraft said. “We’re in totally uncharted territory.”  (See “How low will prices go?“)   Actions cause reactions, and nobody really knows how all this will unwind.  All we really know is that more surprises lie ahead.

That said, I just got off the phone with Blair trying to figure out a way to move up the time frame for getting a couple of our new listings onto the market.  We believe any seller who needs to sell in the next year or two should give very serious consideration to getting their home on the market now.

It’s still possible to sell for top dollar in 30 days.  (See “How to sell your So Cal home for top dollar in 30 days.”)   But you need an experienced, honest, diligent and competent agent who’ll tell you the truth, not what you want to hear (see ” Top 5 ways NOT to pick an agent“).   (BTW, my cell is 562.822. 7653.  If we can’t service your area, there’s a good chance we know or can find a good agent who can.)

Overencumbered (”upside down”) sellers: You have several options:  See “Trouble making your mortgage payment?  7 ways to get back on track” for starters.  There are tax breaks for sellers being foreclosed and participating in “short sales,” where the lender takes a discounted payoff so you can close escrow.   But as things stand now you won’t get those breaks if you close escrow after the end of the year.  Same if the trustee’s sale’s in 2009.  That may get extended, but I wouldn’t bet on it.  Again, we’re only a phone call or a “comment” away if you want to discuss your situation.

Potential buyers: Prices coming down as rates go up doesn’t really help with your payment.
We recently wrote a post discussing specific buyers who might benefit from buying in the current market (see “Time to buy?“).  Move-down and move-out buyers, among others, might find real benefits right now.

If you’re not yet in a position to buy, take advantage of the time you’ve probably got to get ready.  That means saving a down payment or at least closing costs, working on your credit score.  (Try annualcreditreport.com, a free service of the credit reporting firms.  Don’t use freecreditreport.com, which isn’t really as free as it sounds.)

Winter’s usually best for market timing if you’re a buyer. This year, lots of lenders will be trying to close sales by year’s end.  By fall we’ll have a better idea of if the bottom’s likely to be this winter, next, or later, so “stay tuned.”  An RSS feed’s not a bad idea, my 16 year old says it’s easy to do from this blog–if you don’t understand that, ask your kid.  If you do, maybe you can post a comment & explain it before I can get Nate to do so.  (Finals and all coming up.)

Perspective:

Every market presents challenges and opportunities.  These are times when you need experienced, informed, honest professionals to help you make the best decisions.  They are out there, hidden among the pretenders.  Hopefully we’ll have a post up soon on how to spot them.  In the meantime, you can check out “Top 10 ways NOT to pick a real estate agent,” or give me a call (562.822.SOLD).

The challenges we face in today’s market, while serious, are nothing compared to what thousands are facing right now in Burma and China.  Or thousands more in America who, like Ted Kennedy face serious diseases.

For an inspiring story from the pages of the OC Register about a handicapped young man overcoming challenges, you might want to check out “A little perspective.”   I also appreciate my pastor’s reflections on the classic Biblical book of Job.