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 in 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

Divorce Appraisal Clipboard

Recently, I was doing some research on the US Patent office website and ran across this little Gizmo -- the Bullet-proof Clipboard with built-in Pistol. As far as I know, this product never made it to market, but I bet that there are more than a few appraisers who felt like they could have used one of these on an inspection or two. One particular inspection that I did for a Divorce comes to mind. Both the husband and wife insisted on being present during the inspection. Needless to say, things got a little heated. Fortunately, no favorite china or coveted high school trophies were launched across the room, but there was no shortage of tension in the air. The nicest feature of this clipboard is that you can block bullets with it while you run for cover.

For the full description... Link to the US Patent Office

Thinking outside the Grid

Appraising is not as easy as finding three comps that look like the subject, making several “rule-of-thumb” adjustments, waving the magic clipboard and saying Whala! Miraculously, the correct value does not just appears before your eyes. The appraisal form is not a magical tool that gives you the right value. Actually, the adjustment process can deceive you into thinking you have found the right value, especially if you start your analysis with the wrong comps.

The job of the residential appraiser, which has become overly focused on “filling out of the form” has caused many appraisers to adopt a form-driven approach to determining value. This is concerning to me because it is limiting the appraiser’s ability to think like the typical buyer in the market. The appraiser’s thought process is becoming too far removed from actual market participant’s. I have never seen a buyer in the market “gridding” comps before making an offer. Why should the appraiser need to “grid” comps to determine roughly what the subject is worth?

Appraisers should refrain from jumping into the analysis section of the report (gridding comparables) prior to having a good “ballpark” ideal of the subject’s value. If an appraiser does not have a “rough” ideal of the subject’s value, then he/she should not be gridding comps or making final decisions on the comparables to include in the report. Residential appraisers can sometimes fall into the trap of choosing and analyzing comparables based on solely Underwriting guidelines. This approach to the appraisal process can result in completely erroneous value conclusions.

Often, the primary cause for an incorrect value conclusion is not realizing the impact of location, which we all know has a major influence on value. Perhaps this is overlooked (especially by newer, less experienced appraisers) because location is somewhat more elusive than a factor like style, age, or bedroom count. The later are easily identifiable from the data. Merely choosing comps that “look” like the subject without adequate consideration of the subject’s location could leave the appraiser completely blindsided. It is quite dangerous to make comparable selections based mainly on overall style similarity without adequate consideration of the subject’s location.

Analysis of the wrong comps with “rule-of-thumb” adjustments and failing to recognize and account for location differences will cause the appraiser to conclude the WRONG value. Below are some steps to avoid this mistake…

1) You should develop a ballpark ideal of the subject’s value using a qualitative approach before employing a quantitative analysis (gridding comps).

2) Start your search for data with a broad range of criteria and then narrow the data down… like you’re zeroing in on the value.

3) Be cognizant of the potential high and low value for the subject as you work towards the middle of the range.

4) Look at all activity (Sales, Listings, Expired) in the subject’s immediate vicinity (i.e. block or two). Often, active and expired listings will help you establish an upper end of the feasible range.

5) Find several sales, not just 3, that represent the likely range of value for the subject and array this data from low to high. Placing the subject within this array will help you get a better understanding of how the subject relates to both inferior and superior properties in the market. Qualitatively consider comps on the basis of either overall inferior or overall superior. If you can’t determine either because of equal offsets, then it is probably overall “equal”.

6) Determine a narrow value range for the subject property based on this qualitative analysis. At this point in the process, you should have a fairly good “ballpark” ideal of the subject’s value.

Gridding comps should be thought of as more like a fine tuning of the data through detailed analysis. The presentation of comparables in the appraisal report grid is a formal, analytical, presentation of the subject value… not the primary tool for determining the subject’s value. These tips may aid an appraiser in breaking out of the mental block caused by a form-driven approach and allow the appraiser to think outside the grid.