Note to blog readers:

On Monday July 25th we released a report on reported median and average house prices and the Case-Shiller index and why nothing can be trusted in this unprecedented housing market.

We mistakenly entitled the report “Case-Shiller Confirms False Bottom in Housing’. The title was supposed to be ‘DataQuick Confirms False Bottom in Housing’ pointing to a press release within this post. We apologize for the confusion.

There are three significant factors occurring that are influencing the outcome of the reported median and average house price indices. They have nothing to do with home price appreciation in the historical context and are absolutely unprecedented in nature.

Seasonality Mix-Shift – The Push-Pull Effect on Prices Creating a False Bottom

I discussed this effect in detail over the past 90-days. Essentially, foreclosure resales which are not seasonal by nature have remained relatively flat in count in CA and on a national level for months. But during the slow fall and winter seasons they made up the majority of sales because organic sales were so low due to typical seasonality.

Because foreclosure resales carry a lower price point than equivalent organic transactions the reported median and average house prices were pulled lower toward the distressed market price. However, as the busy spring and summer season came on and more organic and mid-to-high end sales occurred, the reported median and average prices were pulled back towards the higher organic market price. Boom – we have a ‘housing market bottom’.

The first chart highlights the seasonal organic sale vs not seasonal foreclosure resale mix shift and how prices pulled higher as organic sales reclaimed the mix for the summer selling season.

The chart below is another look at the sales mix-shift. Three years ago the market was healthy with most sales being organic (blue) in nature. Now with epidemic negative equity that prohibits at least half of homeowners in the bubble states from selling and re-buying, organic sales have plummeted and remain down nearly 60% from 2006 levels.

Apples to apples — assuming foreclosures and foreclosure resales never surged in the first place — the blue portion of the chart is the organic CA housing market. In addition to being down nearly 60%, organic sales are not up too much over last year underscoring how critically injured the market remains from negative equity and the loss of affordability through exotic finance.

Mid-to-High End Sales – Very Important. Not Representative of True Market

More mid-to-high end sales are occurring this year than last. Sales are not anywhere close to the bubble years due to the catastrophic loss of affordability through exotic finance but they have increased nevertheless. They are occurring at significant discounts to list prices and previous year’s sales as I have highlighted many times. At the same time, foreclosure-related resales are falling as demand from first-timers and investors who have carried the market for a year has peaked.

This seasonal mix-shift is almost exclusively responsible for the significant house price appreciation in many CA MSA’s over the past 90-days. Mid-to-high end sellers and buyers are the most seasonal of all. As soon as the summer warm months are over and kids are back to school these sales will drop considerably allowing foreclosure resales, which are not seasonal, to reclaim this mix. This will drop reported median and average house prices as early as September, which should be picked up in the October headlines. Because Case-Shiller lags several months, a fall beginning in Sept will not be picked up until Dec release at the earliest.

Who is the Mid-to-High end Seller & Buyer? Why Is This Important?

Now, think about those that are selling these mid-to-high priced houses. Other than short sales, the majority of sales are not from those who bought new and existing housing stock from 2005-2007 on a Pay Option ARM with 5% down because they can’t sell. They are from those who bought years ago or those who have enough equity to dump the price, sell, and have enough left over for the down payment on the house they plan to steal in the desert.

The primary buyer population in the mid-to-high end is a) that special buyer who can afford the down payment on a new house while renting their current residence b) the mid-to-upper end earner who has been renting either because they just never bought during the bubble years c) those whose earnings situation is actually improving d) young professionals who were not in the position to buy in the past that find today’s prices attractive.

But because of the supply/demand imbalance that exists in the mid-to-high end, it is absolutely a buyers market in contrast with the low end where we have a sellers market. Therefore, the majority of mid-to-high price band transactions are the best properties selling to the best buyers who may even pay a premium for their perfect home in some cases. These are not speculators by and large.

This is a complete departure from the bubble years when move-up buyers controlled the market and virtually every house sold to anyone that could complete a loan app. Back then a much wider variety of houses traded at a much greater frequency. Half the houses in the bubble states may not even trade for at least a decade given the epidemic negative-equity, excessive household debt levels, and lack of affordability through exotic financing that was responsible for the liquidity in the mid-to-upper end markets. In a nutshell, the more transactions across the greater number of price bands the more accurate prices indices will be.

But even with the price dumping at the mid-to-high end this season, a person who bought in 1999 for $450k — who saw their house price rise to $1.5 million by 2007 and subsequently drop to $700k — realizes a price gain. The mid-to-high end new house purchased for the first time just a few short years ago in a plowed over corn field for $1.25 million that is now worth $700k is transacting less frequently.

The bottom line is that house price indices such as Case-Shiller report what sold, period. It is my opinion that the real estate market is so thin and fragmented across all pricing bands, that what is selling today is not representative of the true real estate market. This is especially true at the mid-to-high end. And they likely are not accurately representing properties built and purchased during the bubble years — that have been hit especially hard — and are now worth a fraction of their purchase price because they are not transacting as frequently.

But one thing is for sure — the second derivative is that the homeowner who bought during the bubble is sure feeling the negative-equity pain from the comparable sale at $700k. So much so, he is at an exponentially greater risk of loan default and foreclosure.

DataQuick Confirms That Recent House Price Gains are Abnormal and Likely Temporary

Proof in point comes from DataQuick’s recent Bay Area House Sales report below. This is the first monthly report in which they cite many of the same premises that we have been waiving flags over for months as the reason for abnormal house price movement. An annualized appreciation rate of 146% will only lead to disappointment when foreclosure resales once again reclaim the majority when the summer busy season ends.

Bay Area home sales hit 4-year high; median price up again
August 21, 2009

La Jolla, CA.—-Bay Area home sales rose last month to the highest level for a July in four years as deals above $500,000 continued to accelerate. The median sale price climbed above the prior month for the fourth consecutive month, lifted by the combination of more high-end transactions and fewer sales of lower-cost, lender-owned foreclosures (my emphasis), a real estate information service reported.

The median price paid for a home in the nine-county region rose to $395,000, up 12.2 percent from $352,000 in June, but down 16.0 percent from $470,000 in July 2008, according to MDA DataQuick of San Diego.

Although last month’s median was 36.2 percent higher than the current cycle’s low of $290,000 in March this year, it was still 40.6 percent below the peak $665,000 median reached in June and July of 2007.

The median’s $43,000 gain between June and July was mainly the result of a shift toward a greater portion of sales occurring in higher-priced neighborhoods. The trend has been fueled this summer by several factors, including: More distress in high-end areas, leading to more motivated sellers; more buyers sensing a bottom could be near; and increased availability of larger home loans, which had become more expensive and far more difficult to obtain after the credit crunch hit two years ago (my emphasis).

Foreclosure Moratoria and Mortgage Mod Initiatives – Foreclosures Pushing Up Prices

A certain percentage of foreclosure resales are also artificially pushing up the reported median and average prices as of late. This has to do with the back log in foreclosures, servicers getting the houses back onto the open market in a timely manner, and the surge in investor interest.

For years, the foreclosure process was relatively smooth and consistent across servicers. When the property went to the courthouse for sale it was either bought by a third party or by the bank and placed in REO. The REO would then get listed with a Realtor and sell rather quickly. But there was so little of it, it was insignificant.

However, in these unprecedented times servicers all act independently of each other and inconsistently relative to past years. Houses can either come right back out the other side after foreclosure or be held for months. As of late, the time interval between the transfer back to the servicer and final resale to an individual buyer has been as lengthy process. Because of this, investors — that have become a significant presence in the foreclosure resale market segment — have significantly impacted the reported price outcome.

There are two primary investor types — buy and rent and buy and flip. Many flippers fix up the property and hope to resell for a higher price, which isn’t hard. If the house is flipped at least six months from the date of transfer back to the bank at Trustee Sale, then it counts as a pair sale in the Case Shiller unless the final sales price is completely out of scope and it is discarded.

Because Case Shiller gives more weight to houses that transfer within a shorter amount of time, these slightly greater than 6-month flips can carry a lot of weight. If they make it through to the index, foreclosure resales are given much more weight than ever before especially given they have ranged this year on a national basis from 31% in July to over 50% at the beginning of the year.

Foreclosure Resale Paired Sales Not Representative of True Market Appreciation

But as with the inconsistency in the mid-to-high end, a foreclosure flip — where the investor likely put lipstick on the pig before selling — is not representative of the overall market either. Very few low to low-mid price band sales from purchases made from 2004-2007 are occurring organically because the owners are too far underwater to sell. This increases the range of what is considered in scope and allows more of these types of transactions to make it to the index further skewing the results.

Giving an increased weighting to legitimate arms-length foreclosure resales flies directly in the face of the CS methodology. CS makes the assumption that the longer the time interval the more chance for property change or rehab thereby given them less weight. In this unprecedented market, many low to low-mid price band sales have indeed experienced the physical changes negatively mentioned in the CS methodology excerpt below.

The bottom line is that house sales in 2009 are keeping pace with last year, which happened to be the worse year on record in many aspects of the market. If not for massive temporary stimuli who knows where the market would be today.

Prices have likely stabilized at the low to low-mid end of the spectrum for now. In the mid-to-high end price bands, sales and prices are far from a bottom. The coming house price compression and record-high foreclosure pipeline supply will likely bring further pressure to the low end.

But even if the low end has bottomed with respect to sales, seasonality trends will pull prices back down when organic sales go away, as they always do in the fall and winter, and foreclosure-resales once again reclaim the mix. Even though we will not see the size of drop seen over the past two years, reported house prices rolling over will significantly impact sentiment.

When Will Housing Bottom?

We will not know it when the US housing market finally bottoms. It will not be foreseen in any of the typical indicators we presently watch. It will likely come when my Uncle Frank the plumber — who is out there every day trying to find a fixer upper — can’t stand the thought of real estate and buys a water purifier in a multi-level marketing scheme.

Best Regards,
Mark Hanson

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Filed on: August, 26 2009 by Mark

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