Oct132009

Alternate housing market price measurements

The median sales prices does not give any indication of what was obtained for the money spent. Median prices may be flat while people are either getting more for their money or settling for less. Also, the median sales price when charted over time occasionally gives false signals when prices appear to be moving on one direction when the prices of individual properties in the market are moving another. To deal with these problems with the median, alternate measures of pricing are used.I_want_to_believe

Cost Per-Square-Foot

Many data reporting services measure, record, and report the average sales cost on a per-square-foot basis to address the problem of evaluating what buyers are getting for their money. For instance, in a declining market if people start buying much larger homes at the limit of affordability, the generic median sales price would remain unchanged, but since buyers are getting much larger homes for the same money, the average cost per-square-foot would decline accordingly. This makes the average cost per-square-foot a superior measure for capturing qualitative changes in house prices; however, this method of measurement does not capture the relative quality of the square footage purchased, only the price paid for it. High quality finishes may justify a higher price per square foot. There is no way to objectively evaluate the impact finish quality has on home prices. The main problems with using the average cost per-square-foot to measure price is that it does not provide a number comparable to sales prices since it has been divided by square feet, and it is not widely measured and reported.

S&P/Case-Shiller Home Price Index

To address some of the weaknesses of the generic median sales price as a measure of market value, Karl Case and Robert Shiller developed the Case-Shiller indices for measuring market trends. This index measures the change in price of repeat sales. It solves the dilemma of pricing like-kind properties–almost. Although these indices capture the price movements of individual properties far better than the generic median sales price, it does not take into account value added through renovation and improvement. To address this issue, the index gives less weight to extreme price changes assuming the outlier is a significant renovation. However, if there is a market-wide renovation of properties, as was the case in many markets during the Great Housing Bubble; this will cause a distortion in the index.

National S&P/Case-Shiller Home Price Index, 1987-2007

S&P-Case-Shiller Home Price Index, National 1987-2007

 

The other weaknesses of the Case Shiller indices concern how and where it is reported. Since it is an index of relative price change rather than a direct measure of price, the index is reported as an arbitrary number based on a baseline date; therefore, the numbers are not useful for evaluating current pricing. The index is also confined to 20 large metropolitan areas around the United States. The large geographical coverage areas are required to obtain enough repeat sales to construct a smooth index. The broad yet limited geographical coverage fails to capture price changes in smaller markets. Also, since the Case-Shiller index is a measure of changes in prices of sales of the same home, it does not include any newly constructed homes. No measure is perfect, but the Case-Shiller index is the best at measuring historic movements in pricing because its methodology is focused on repeat sales of the same property.

Los Angeles S&P/Case-Shiller Index, 1987-2007

S&PCase-Shiller Index, Los Angeles 1987-2007

 

The Great Housing Bubble was an asset bubble of unprecedented proportions. Between 2000 and 2006, home prices increased 45% nationally, and in California home prices increased 135%. [iv] Had this amazing price increase coincided with a period of high inflation, it may not have been indicative of a price bubble, merely the general increase in prices of all goods and services; however, inflation was low during this period. The inflation adjusted price increases nationwide were 23% and in California it was 100%. There was no great improvement in the quality of houses justifying the higher prices. Although some homeowners made cosmetic improvements, the vast majority of homes were unchanged during this period, and many deteriorated with age. Resale homes did not undergo any form of manufacturing process where value was added to the final product. There was little real wealth created during the bubble, just a temporary exaggeration of value.