Making sense of market indicators, part 3: sales price.

Of all the market indicators, what could be more straightforward than sales price? What number could less need interpretation? Prices are either down, or they’re up, or they’re flat. And that’s that.

I’m going to answer these questions by putting you in a life-like vignette, so life-like it could be ripped from the pages of real life and is. You’re going to be a composite of a number of clients over the past ten years. Any resemblance to current clients, living or dead, is purely coincidental.

Let’s say you’re looking for a home in a local city widely perceived as highly desirable, Palo Alto, which, in a transparent attempt to broaden the appeal of my Web site beyond this area, will henceforth be known as “Wonderfulville”. You’re focusing on Wonderfulville because it’s known for having the best public and private infrastructure in the region. You may have family or friends in Wonderfulville. You may even have tried to buy in Wonderfulville in the past, but were fazed by its exorbitant prices. But you’ve been following the real estate market—who isn’t?—who can avoid it?—and you know it’s hit a rough patch. Month after month, you see sales prices plunging. In California. In the Bay Area. In much of Santa Clara County, where Wonderfulville is located.

And Wonderfulville certainly looks like one of those bubble markets everyone who knows says must go down. So you decide you’ll poke around there and see what kind of bargain you can pick up.

You start looking in late 2007 because you figure the credit crunch caused by the August implosion of the subprime market will finally cut off the air to Wonderfulville real estate. But prices still seem high. Really high. Really high. You investigate and discover that home prices are about 36 percent higher than when you walked away from the Wonderfulville market shaking your head two years ago.

You go back and check the news reports that propelled you into the marketplace in the first place. Bay Area home prices down 4.6 percent from last month. Check. Santa Clara County prices down 37.8 percent—no, wait, sales are down 37.8 percent. County-wide prices are up 3.7 percent. What’s up with that? How can home prices go up when sales go way down? Oh yeah, it says here it’s because the top end of Santa Clara County real estate is still doing well, even as prices crash and foreclosures surge throughout the affordable parts of the county. But everyone who knows says the writing is on the wall for the top end too. It’s just a matter of time before prices go down in every city. And you’ll be poised and ready when they do.

You hook up with an agent and look at more homes. You notice that every open house is crowded. Your agent tells you that agents swarm the houses you like during broker’s tour, and with gas at almost $4 a gallon, agents aren’t touring homes unless they’ve got buyers for them. Well, Rome wasn’t built in a day, and it didn’t fall in a day. Besides, nothing you see moves you, and prices still seem really high. Really high.

Fortunately, your agent turns out to be the analytical type, and he does a Comparative Market Analysis for each home he shows you. His CMA uses “comps” (recent closed sales) going back a few months to calculate a “suggested price range” for the home in question. The range isn’t just one sales price; it’s a sales price plus-or-minus 2.5 percent, suggesting that there isn’t just one price for a home but rather a range of sales prices that the offers of serious, qualified buyers will fall into. Your agent’s price ranges turns out to be pretty accurate. Homes usually sell for what he thinks they’ll sell for. And man are those prices high.

Months pass and you finally feel comfortable enough to make an offer. Your agent says that, based on recent sales, the home you’re gunning for may sell for as much as X. How much should you offer? For days you and your spouse go back and forth, weighing pros and cons, desire for a deal wrestling with desire to own the home. You don’t want to pay too much. But you do want to live in Wonderfullville. Finally you swing for the fences and go with that big X number.

But this time your agent tells you he isn’t sure about his CMA. The most recent sale in the same neighborhood sold for about 5 percent more than he thought it would. Did some buyer, desperate to live in a popular neighborhood and frustrated by losing repeatedly in multiple offer situations, simply lose his cool and pay too much? Or have home prices really gone up 5 percent? Your agent says it’s the right time of year for prices to spike. But this year? With all this bad news? He goes with his gut and says he thinks the home you want will sell for more than the comps say. Not as high as Y, but something close.

But you know that one sale does not a market make. Or maybe it does. Because your offer at a “market correct” X is the lowest of four offers. The seller’s agent tells your agent the home sold for “close to Z”. A few weeks later it closes and you see the sales price: Z minus $10k.

Yikes! That’s way too much money, almost 4 percent more than your agent’s CMA said was the most the house would go for. 4 percent might not sound like much but, to paraphrase the late Everett Dirksen, in this price range “one percent here, and one percent there, and pretty soon you’re talking real money”.

Your agent is convinced that prices have suddenly jumped about 5 percent. He’s seen it happen, especially in the spring, but the funny thing is, Wonderfulville’s statistics don’t show it. You’ve given up using Bay Area sales prices, and even Santa Clara County sales prices, to make sense of the Wonderfulville market, but shouldn’t city-wide prices confirm what you’re seeing or think you’re seeing? Nope. Both the median and average sales price for Wonderfulville are down this month. Another fluke? How many home sales does it take to make a market trend?

More homes come on the market, and your agent does a CMA for each and every one you see, but you can tell he’s lost confidence in them. He starts telling you, “this home will sell at the top end of its price range, or higher”. These days he’s flying by the seat of his pants, believing only the most recent closed sales, even trying to magically unlock sales prices from sales that haven’t closed yet. Because he knows that a price run-up has momentum. Homes are still selling for 5 percent and sometimes 8 or 9 percent more than his CMAs say they should. You look at the new city-wide stats. Now, instead of missing the run-up they seem to be exaggerating it, showing home prices up 12 to 15 percent for the month.

The next month is more of the same, homes selling for well above the comps and, this time, the Wonderfulville stats show prices down 15 percent! And that house you offered X for? Now you’d gladly offer Z. Now Z seems like a good deal. But that was then, and this is now. And now the bar has been raised.

About this time your agent talks to another Wonderfulville agent he thinks is savvy and asks this leading question: “I think prices have gone up 10 percent this March and April. What do you think?” At first the agent doesn’t understand the question, then responds, “No, I’m seeing buyers rebel at these high prices”. Your agent mentions a home that sold $400k above the comps. “Yes, but that was location.” Your agent knows about location, knows it matters, which is why he used only comps in that location, yet the house still sold for $400k more than the comps said it would, but he lets it pass. “How about this other sale?”, he asks. “Yes, but that’s because two more expensive homes for sale on the same block made that lower-priced house look like a good deal.” Your agent wonders how anyone who works with buyers would think they were that simple.

Your agent decides to quantify this shadow price run-up and finds the sales price numbers still not cooperating. Remember, Wonderfulville’s sales price stats tell him this:


But what he’s seeing on the ground looks like this:


Your agent spends a morning slicing and dicing the numbers until he comes up with this:


Okay, this is more like it. This shows a sales price trend that bears a startling resemblance to real life. How’d he get it? Your agent has gone back to October, when you and he first started looking at homes, and tracked the sales price trend (in sales price per square foot) of every home you saw. December and probably January average sales prices turn out to be useless because so few homes sold in those two typically slow months. But what’s left shows him what he’s long suspected: you’re in the hottest segment of the Wonderfulville market. The homes you like, the homes you’re looking at, are the homes most Wonderfulville buyers like and are looking at. And making offers on. Very good offers indeed. But masking this frenzied sub-market is the fact that buyers have shoved many of Wonderfulville’s homes for sale to the back burner. Sure, this back-burner market is still mighty good and better than most, with homes still selling, often fairly briskly and for top dollar. But the slower activity of the overall Wonderfulville market means its sales price numbers are masking the rising prices of the core of homes you and most other Wonderfulville buyers like. That’s why the average and median sales prices for Wonderfulville don’t agree with your experience. But you know that red-hot sub-market exists, and your agent knows it exists, and now, finally, it’s been sighted and quantified. But it took work and on-the-ground experience and plenty of educated interpretation to do it.

What have you learned from this?

1. National, state, regional, county, even city sales price trends may not reflect what’s going on in your neighborhood or in the neighborhood you want. All may understate or overstate changes in prices, sometimes significantly.

2. What’s the fool-proof way to spot changes in market value: average sales price, median sales price or sales price per square foot? All have their pros and cons. Average sales price can be influenced by anomalies at either end of the price range. Supposedly median can’t, at least not as much, but it too can be skewed by unusual activity at either end of the price range. How about sales price per square foot? All things being equal, smaller homes sell for more per square foot than larger homes, since so much of the value of a home in this area (and probably in every high-demand area) is in the land the home sits on, and on the bundle of benefits that go with a particular neighborhood, city or region. So an increase in sales price per square foot may simply mean that more smaller (and cheaper) homes are selling. (The reason it gave a true picture in the example above is that the Wonderfulville homes that buyer and so many others liked were all roughly the same size.) But home size still matters, and the relatively small number of sales involved when comparing price changes in neighborhoods and even cities means average home size can vary greatly between the periods compared. So after ten years of trying to make sense of real estate numbers—and this is far more difficult than the amateur market-watchers realize—I’ve come to the conclusion that the best way to measure changes in price is to knock the anomalies off both ends of the range, then adjust the market periods being compared to the same square footage. But this is still as much art as science.

3. Sales price is perhaps the least-helpful and most-guessed at of market indicators, because it’s a lagging indicator. Buyers in every other market I’m aware of know market value instantly as transaction prices are posted. In real estate, the transaction price often isn’t posted until thirty days or so after the event that triggered it. In a volatile market, a month’s delay is far too great to help determine today’s market value.

4. In real estate, determining the “market correct” price of a home rests squarely on the shoulders of the buyer agonizing over the sales price she’ll offer. The experienced and realistic buyer often develops an extremely accurate sense of market value, and his or her agent can help with an educated guess, but when all is said and done, the buyer must look both within and without, at herself and at her competition. Because of this subjectivity, market value can vary from buyer to buyer, within a numerically broad but still relatively narrow range, depending not just on the financial constraints of each buyer but also on their desire, confidence and aggressiveness. These last three traits can change dramatically over time. In fact, they have to, for the buyer to achieve her goal. Thus one buyer can be many buyers over months of activity in the marketplace, as she progresses from the various stages of also-ran to winner.

5. Even in a booming market like Wonderfulville, a house is what might be called a “thinly traded asset”. While two hundred people may troop through a home during a week-end of open houses, the responsibility for setting the market value of that home rests with just a handful of buyers. If “only” three or four buyers make offers on that house, their divergent needs and expectations may well—and often do—result in a divergent range of offer prices. Because of this, there is no one correct sales price, engraved in stone, for any house. Instead, each house has a range of likely sales prices, matching the range of likely buyers for that house.

6. Market value can change from month to month and even from week to week. Thus, last month’s sales price may or may not be an indicator of this month’s sales price.

7. One transaction does, more often than not, a market make. Ignore that anomalous new sales price at your peril.

8. The more sought-after the community, the more “emotional” demand will be for that community, and the more volatile and unpredictable its sales price movements will be. The “emotion” of the market for a highly desirable city like Wonderfulville can make the most recent sales price seem inexplicable. Until the next sales price makes it a trend.

In two weeks, Making sense of market indicators, part 4: overbids.

copyright © John Fyten 2008

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