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Weekly Economic Commentary


What’s A House Really Worth?

August 28, 2012

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Despite the well-documented correction in real estate prices, our property taxes have been slow to react. My wife is on a singular mission to correct this asymmetry, collecting evidence from a variety of sources that suggest that our house is relatively worthless. Good thing we don’t need a home equity loan.

Her search is complicated by the wide range of valuation indicators on single family dwellings. Our housing stock is quite heterogeneous, and location plays a significant role in determining value. Unless a home actually changes hands, getting a clear price is not easy; and even then, there are those who suggest that the degree of “distress” surrounding the transaction can diminish the relevance of the observation.

We learned this morning that the Case-Shiller index of 20 leading markets showed its first year over year gain since the expiration of the first-time homebuyer credit in 2010. This is certainly encouraging; but when viewed against history and the performance of other house price indices (HPIs), progress still seems very modest.

Chart 1 - 08 28 2012

Understanding the construction of the leading HPIs can help provide perspective.

The National Association of Realtors publishes a median sales price for homes each month. It makes no adjustment for the types of homes being sold; if a large number of expensive houses change hands in a given month, the index will register an increase that may not be very representative of the overall housing market. This metric therefore does not get as much attention from policy makers.

The Case-Shiller Index and the FHFA Index are both “repeat sales” metrics, which track how the value of individual properties evolves from one sale to the next. The benefit of this approach is that it holds the characteristics of the property largely constant (home improvement and changes in the fabric of the neighborhood are still at play).

The FHFA index is drawn from homes which are financed through Freddie Mac and Fannie Mae, which limits the price point to the conforming mortgage maximum (currently $417,000, with some exceptions for high-cost markets). It therefore under represents the high end of the property market, where price declines have been accentuated by the closure of the secondary market for jumbo loans.

The Case-Shiller Index attempts to broaden the sample by going to records of deeds, and is therefore more inclusive. It also weights its core observations a little differently, and the index of 20 major markets is more narrow than the broad FHFA sample.

The limitation of repeat sales indicators is that they are formed only from homes which change hands, and therefore may not be as applicable for those which have not been listed. In today’s environment, homes whose values have declined substantially (and which may be “underwater” relative to the mortgage on the property) are far less likely to be listed and sold.

The analysis surrounding today’s Case-Shiller reading suggested that the improvement was partly due to a lower proportion of “distressed” sales. But with a lot of properties still distressed, mix changes in future quarters may limit further gains in the index.

Further, the perception of a modest recovery in prices may prove self-correcting, as fence-sitting home owners list their property. This movement of shadow supply into the market can serve to place a cap on gains in value.

So while it is very likely that house prices are near, or slightly past their bottom, it is also likely that gains in value from here will be modest and gradual. And there will still be price points and geographic markets that could decline further.

Home values have a wide range of influences on economic activity. They represent a source of wealth and saving, which can affect consumption and investment decisions. And they can serve as a source of equity for purchasing a different home. If we can begin restoring some of the $7 trillion in wealth destroyed during the crisis, we might be able to reverse some the adverse effects on economic performance.

The Federal Reserve has taken a keen interest in this dynamic, releasing a housing white paper at the beginning of this year. It wouldn’t be a surprise if Chairman Bernanke mentions this sector in his speech at Jackson Hole this Friday.

As for my wife’s endeavor to cut our taxes, she’s built a hedonic model that relates local house prices to square footage, key features (granite vs. laminate countertops, stucco vs. wooden siding, etc.), and the distance of the unit to the nearest public park (adjusted for the quality of the jungle gym). That University of Chicago background sure comes in handy.






The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.