Is the Housing Market Worse Than It Seems?

by: IndexUniverse

The housing market feels like its falling apart. The newspapers are full of stories about falling prices and rising inventories. Where I live, “price reduced” signs are popping up, and some houses have been on the market for more than a year.

And yet, as we've reported before, housing statistics and indexes tell a different story. The Commerce department said recently that the national median home sales price rose 0.3 percent in July, even as the number of new homes sold fell over 21 percent. The National Association of Realtors said that prices rose by 0.9 percent.

The new housing price indexes say the same thing. The most recently released data form the S&P/Case-Shiller Home Price Index – covering May sales – showed a year-over-year price increase of 9.7 percent. Prices fell in only one regional market – Boston, where values fell 1.4 percent – while Miami posted a 22 percent gain and Los Angeles saw a 15 percent rise.

I have been utterly baffled by this discrepancy: How can the market feel so bad, and yet perform so well? A 9.7 percent gain in a year when the market feels like this? It just doesn’t seem right. Could the indexes and data be lying?

As it turns out, the answer might be yes. An article in Saturday’s New York Times points out a fundamental and increasing important flaw in the housing data that might explain the difference between my perception and the indexed reality. According to the Times, there has been a huge rise in the use of “incentives” to sell homes - incentives that do not show up in the official "selling price." And because all the indexes rely on official selling prices, they are starting to systematically overstate the average value of homes in America.

We're not talking small potatoes, either. According to Lawrence Yun, a senior economist with the National Association of Realtors, incentives may equal 3 percent of house values nationwide. Regionally, in areas like Florida and California, the number may be higher still.

Sellers are offering anything and everything they can think of to convince home-owners to buy ... without lowering prices. They’re paying closing fees and throwing in bonuses like hardwood floors and granite countertops; they’re offering vacations and timeshares; they’re giving away new cars and boats. Some sellers are offering bounties – as much as $10,000 - for anyone who brings a real liver buyer to their homes.

The use of incentives makes sense. Sellers are reluctant to cut prices for fear of looking desperate, and real estate agents don’t want to lower prices because it would impact commissions. But these incentives add up.

But there is no way to capture these incentives in the data, and they don’t trickle down into the housing price indexes. If home X sells for $250,000, it goes into the books for $250,000, even if the seller paid $15,000 in closing costs and threw in a $30,000 swimming pool to close the deal.

The rising use of incentives throws into question the utility of the new housing price futures and options. As incentives come to represent a larger and large value of current home sales, traders looking to hedge against (or speculate on) a housing bust will be at a loss .. both literally and figuratively.

Eventually, it seems to me, the negative pressures on housing prices will overwhelm the incentives. If housing prices fall 15 or 25 percent, as I suspect they might, no amount of incentives will mask the decline. Nonetheless, incentives could mask at least part of that impact in the housing futures market, making the novel products less valuable than they otherwise may be. Financial products are only as useful as the data behind them, and with sellers and real estate agents "messing around" with that data, the value of these new products is at least somewhat diminished.

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