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Keepin' It Real Estate: Why Housing Prices Are Essentially Meaningless


Getting to the "bottom" of the housing market.

It took the Wall Street Journal an entire survey to prove what readers of this column have known for months: The housing recovery, as it plays out, will be a localized event, varying greatly city to city, neighborhood to neighborhood, street to street.

The Journal, God bless them, compiled housing data to compare inventory changes, months supply, price drops, unemployment, and default rates across 28 US metro areas. Unsurprisingly, bubble markets like Las Vegas, Phoenix, and Miami look particularly horrid, whereas areas like Dallas (which avoided much of the housing mania) and cities like Charlotte and Seattle (which are just now seeing price declines accelerate) appear to be holding up rather nicely.

But drilling deeper into the raw data reveals a housing market that's deeply bifurcated, even within individual cities.

As low-end markets experience a sharp increase in buying activity due to supply shortages and vastly lower prices, illiquid high end markets are experiencing violent price swings -- typically in the southward direction. This much is already known, and the Journal's study simply shows what we're told ad nauseam: Real estate is, in fact, local.

What's far more applicable to home buyers and sellers around the country, however, isn't what a few broad (yet important) data points show about what's happening in a few hundred neighborhoods all lumped together. Instead, it's where individual submarkets are headed. After all, owning a home is an investment in a neighborhood, a street, a community -- not necessarily a metropolitan area at large.

Housing prices, by extension -- when measured as broadly as a metro area -- are basically meaningless.

Real estate, for all its intricacies, isn't any different than any other market: Prices are set by the interplay between supply and demand. The trick, then, is isolating the key data points within an individual micro-market that tell us who has the upper hand -- buyers (demand) or sellers (supply). This is the best short-term indicator of where prices are likely going in the near term.

Unfortunately -- and one of the reasons bottom-calling in the current housing cycle is so dangerous -- myriad behind-the-scenes deals between regulators and big banks like Citigroup (C), Wells Fargo (WFC), Bank of America (BAC), and JPMorgan Chase (JPM) are impacting markets in a material way.

There are a number of important measures of housing supply and demand. And because at Cirios Real Estate we take a bottom up approach to evaluating property values (i.e., house by house, rather than city by city), we pay close attention to the sales-price to list-price ratio.

This ratio simply measures the difference between where a home was listed and where it was sold. To be sure, this can get complicated in markets where price reductions are common. But comparing both original list price and most recent list price to the eventual sales price can yield important insights into a market's true behavior.

As can be seen in the graph below, which measures this ratio in 2 towns in the San Francisco Bay Area, this ratio tends to follow housing booms and busts fairly closely.

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