Making Sense of Marketing and Exposure Time

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Case Shiller Index Revisited

Recently I read a story in Crain’s Chicago Business titled "Local Home Prices Up for 5th Month". The story reported, "an index of local home prices rose for the fifth straight month in September, further evidence that the housing market recovery is continuing. The Standard & Poor’s/Case-Shiller home price index for the Chicago area increased 1.1 percent from August on a seasonally adjusted basis. Local prices were still 10.6 percent below their level in September 2008, according to a report released Tuesday by Standard & Poor’s."

In early 2008, I projected that the Case Shiller index for Chicago would require a 14% drop (about 22 points) off its peak of 162 to return to its long term trajectory. The total drop from the peak has been about 25% (about 40 points), so it makes sense that the index has reversed course. The drop below the trend line is approximately equal to the magnitude of the increase of the index above the trend line - 20 +/- points.

The question now is how steep will the slope of the index be as is moves back to equilibrium. The index was above the trend line for nearly 8 years from 2000 to 2008. Will the return to equilibrium take half that long?

At its current trajectory and slope, the index would intersect the long term trend line by about mid-2010. However, I would expect the slope of the index to decrease and flatten out in the coming months, which would put the point of intersection out to sometime in 2011. Experts warn against concluding that this reversal in the index is a clear sign that the housing market has bottomed. We may experience another dip in the market as foreclosures continue to increase. However, I expect this will merely flatten out the index rather than reverse its direction.

Magic Number Could Be -14%

The Wall Street Journal reported yesterday on two indexes that can show conflicting data on the direction of home prices. These two indexes were the OFHEO index and the Case-Shiller (C-S) Index.

Below I have presented a graph of the C-S index for the Chicago market since January 1991. The index has increased from 80 at the end of 1994 to its present level of roughly 162. The annualized rate of change of this trendline is slightly above 5% per year.

Exhibit 1:



Common wisdom in this area holds that the typical rate of appreciation (prior to 2000) is about 5% annually. The trendline tracks closely with this generally accepted rate of appreciation.

Over the prior 3 years, the index has been above the trendline. It has taken about three years for the C-S index to reverse and come back to the trendline level. To fully recover and get back to equilibrium, it may take another three years below the line.

In order to estimate the amount of the required correction in prices, I have analyzed the Year-over-Year (YOY) rate of change in the C-S index.

Exhibit 2:



During the high-flying years of 2000-2006, the YOY change in prices was about 8% annually. But prior to 2000, prices were averaging about a 3% YOY change. Over the same time period, the annual change in CPI was averaging about 2.5%, so the change in home prices was roughly 0.5% above CPI.

If the market had continued at that same rate of change (0.5% over CPI) from 2000 – 2006, the YOY change in home prices would have been approximately 3.25%. Annual CPI changes from 2000 – 2008 averaged about 2.75%. In January 2000, the C-S index trendline was roughly at 110 (See Exhibit 1). If the index increased by a compounded rate of 3.25% over the next 8 years, it would have been at 142 by January 2008. As of November 2007, the C-S index was at 161.61 or about 14% higher.

A recent article in Business Week described real estate values may need a 25% drop for the housing market to stabilize. The Chicago market has been less volatile and more stable than many other markets in the Nation.

If the Chicago market needs a 14% decline to stabilize, that obviously won’t happen in a single year. Sellers in this market have been quite reluctant to drop prices in order to sell. Most likely, sellers will remain firm and the correction will just require time to reach equilibrium. The typical a long term trend of YOY home price changes is from 3-5%. In order to burn-off the excess value in this market, it will take about 3-4 years for the Chicago market, without further declines in prices. Further price drops will shorten this recovery time. The latest figures from Case-Shiller showed a YOY change of -4.0%. At a -4.0% rate, full recovery may occur after about 2 years.

Elgin Market Conditions

The following chart shows quarterly real estate transactions for the Elgin market over the past five years.


Like the national real estate market, transactions were steadily increasing from 2002 to the end of 2005, hitting a peak near the first quarter of 2006. Since early 2006, sales have steadily declined from a peak of approximately 800 transactions per quarter to current levels of approximately 450 transactions per quarter. The decline in Sale Volume has been approximately 45%. The sales volume has held steady through most of 2007 which may indicate signs that the market is stabilizing.

Although overall number of transactions has declined significantly over the same time period, the median price level has remained surprisingly stable over this period. Median sales prices in Elgin, as shown in the chart below, have generally fluctuated around $250,000 over the last year and a half.

Sub-Prime hits Chicago hardest

The Chicago Reporter studied data released by the Federal Financial Institutions Examination Council and found that the Chicago metro area ranked highest in the country in total high-cost loans in 2006. “High-cost" loans are first-lien loans with interest rates at least three percentage points above the U.S. Treasury standard. Some of the communities hit the hardest are south and west side areas, such as Roseland, Austin, and Dolton. Especially vunerable is the south side community of West Englewood where 75% of loans were high-cost loans.

Link to article...

http://www.chicagoreporter.com/2007/9-2007/mortgage/mortgage.htm

OpenOffice

If your looking for a good alternative to Microsoft Office, try Sun's OpenOffice. This open-source project is a free multiplatform office suite that is compatible with MSoffice. My initial experience with this product was favorable. The spreadsheet was easy to format and sorting a column was quick with a button along the top menu. Graphing was a snap; however, I was not able to plot the linear equation. The word processor has some nice whistles and bells such as automatic word completion and a PDF generator. I would highly recommend this product to anyone that needs a basic word processor and spreadsheet application. It is dramatically superior to google docs, especially the spreadsheet feature.

Appraising Rated in Top 10

Money.com recently rated real estate appraising in the top 10 best jobs. See story below...

Survey Looks at American Jobs