This is a “must read” for everyone in real estate, including brokers, appraisers, lenders, and yes even homeowners. It is not a direct condemnation of the appraisal institute/appraisal foundation, mai, but is illustrative of how their inane practices-the use of non-arm’s length transaction as sale comparables-have extirpated the downward move in real estate prices. One thing important to note is that when the author speaks of “normal” sales or prices is what we in the industry call “Market” sales or prices. All italicized items are comments from Curtis D. Harris, BS, CGREA, REB
The Brookings Institution
What’s Wrong with American Housing? the Appraisal Institute/Appraisal Foundation, MAI.
Foreclosures Are Suppressing Any Major Recovery in Housing Construction
Sales of foreclosed dwellings have increased greatly since 2006, from about 400,000 to almost two million in
2010. Foreclosure sales comprised a large percentage of all home sales in 2010, and will do so again in 2011. It
is difficult to determine exactly how many foreclosed homes have been sold monthly during any of the years from
2006 through April 2011. Realty Trac estimates that total housing foreclosure filings in each year were as shown
in the accompanying table “Calculating Normal and Foreclosure Sales and Prices, 2006-2010.” It usually takes
considerable time for each filing to result in seizure of the home by lenders and subsequent sales to buyers.
Roughly 25 percent of filings in any year result in foreclosure sales within that year; another 35 percent occur as
sales in the following year; the remainder are settled in some other way.
The National Association of Realtors (NAR) publishes the number of homes sold each year and estimates their
median prices. By subtracting the number of foreclosure sales from total sales, one can estimate the number of
homes sold that were not foreclosed. Realty Trac estimates the number of foreclosure filings each year and the
discount at which actual foreclosures are sold below “normal” prices. These inputs were used to construct the
accompanying table “Estimating Foreclosure and Normal Home Sales Prices by Trial and Error, Matching
Estimates to NAR Housing Data, With 30% Foreclosure Discount.”
This table shows that the percentage of all home sales each year consisting of foreclosure sales rose from 8.53
percent in 2006 to 40.2 percent in 2010. This huge increase in the share of all home sales coming from
foreclosures has greatly reduced the average price of all home sales together. Yet none of the three major
home price indicators explicitly takes into account the influence of the rising share of discounted
foreclosure sales upon either the average overall price or the price of normal, non-foreclosed home sales.
As a result, all three price measures over-estimate the price declines of non-foreclosed homes. In fact, in
2010, as best I can estimate, the sales prices of non-foreclosed homes actually rose slightly at the same time that
the three most commonly used price measures showed a slight decline in average housing prices (including
These factors hugely undermined the willingness of possible home buyers to purchase homes. That offset the
decline in home prices that might otherwise have increased home buying incentives.
Three additional factors reinforced the unwillingness of many households to buy a home (reduced demand.) One was the large inventory of unsold homes, constantly replenished by additional home foreclosures. Potential buyers are reluctant
to buy if they believe home prices might fall farther. Another factor was competition from speculative investors
who were willing to pay all cash to buy homes – especially foreclosed homes being sold at large discounts. Such
investors hoped to rent the homes they bought out and later sell them at a profit after the economy recovered.
The Major Measures of U.S. Housing Prices Provide Misleading Information About What
Is Actually Happening to Such Prices
There are three major sources of information about current housing prices in the United States: the Case-Shiller
Index, the National Association of Realtors (NAR) data, and the Federal Housing Finance Agency (FHFA) Index.
The Case-Shiller Index, owned by Standard and Poor’s, is the home price measure most often cited in the media.
It uses matched pairs of two sales of the same homes over time to measure price changes accurately, not
distorted by comparing prices of different quality homes. ( Now one must remember, what is the likelihood of a home selling twice within a short period 2006-2010 if there is sufficient equity, as opposed to one which is underwater over that same period of time. I proposed that most of the paired sales used were foreclosure sales, reo sales, or short sales.) However, it gathers data from only 20 major metropolitan areas in the United States, despite the fact that in 2009 the Census Bureau stated that there were 366 metropolitan areas (each with 50,000 or more residents). The 20 metro areas included in the Case-Shiller Index contained 104.9 million residents, or 40.78 percent of the entire U.S. metro population in 2009. Since the total U.S. population was 307.745 million in 2009, Case-Shiller covered only 34.4 percent of the total U.S. population,
omitting two-thirds. Moreover, the 20 metro areas in the Case-Shiller Index included most of those that had the
largest home price increases from 2000 to 2006. Hence they showed much greater home price increases from
2000 to 2006, and much larger declines from 2006 to 2010, than were true of home sales in the entire nation. This
can be seen in the accompanying chart entitled “Comparing Three Home Price Indices, 1989-2008.” It clearly
shows that the Case-Shiller Index rose much faster than the other two from 2000 through June 2006, then fell
faster than the other two through about May 2009.
transactions in over fifty metropolitan areas across the nation. From these data, the NAR computes the median
sales price for all these areas combined. However, the NAR price estimate suffers from two problems. First, it
uses median prices for each area and for the nation as a whole, rather than average prices. Second, it does not
correct for shifts in the sample of home types involved in sales during each period—so the median price actually
computed for sales in one period can be influenced by a change in the mix of types of homes sold from one
period to the next. On the other hand, since NAR uses data from a much larger number of metro areas than
Case-Shiller, errors caused by shifts in the types of homes being sold in each period are in part offset by the
larger sample of actual sales in far more locations.
The third index is the Federal Housing Finance Agency’s estimate of home sales prices. Its sample is confined to
purchase transactions eligible for financing by Fannie Mae or Freddie Mac. But it also uses data from many more
metro areas, grouped by regions of the country. And it uses the same matched pair analysis as the Case-Shiller
Index to protect from errors caused by changes in the types of homes that are sold in each period.
None of these indexes distinguishes between sales of foreclosed homes and sales of “normal” homes not
involved in foreclosures. But foreclosed homes typically sell at much lower prices than the same homes would if
they were not foreclosed. Realty Trac estimates that the average foreclosure discount is 20 to 30 percent.
Therefore, as the share of foreclosed sales rises in the total number of sales – as has been happening for several
years – the overall prices based on both types of transactions combined tends to decline, even if the sales prices
of “normal” (that is, non-foreclosed homes) are not falling at all. Based on data from Realty Trac, I estimate that
the share of foreclosed sales in total home sales has risen from about eight percent in 2006 to over 40 percent in
2010. For every 10 percent rise in the share of foreclosed homes in total sales above zero, the price of all sales
combined declines by one-tenth of the discounted price of foreclosure sales compared to normal sales. This can
be seen from the accompanying chart entitled “Relation Between Foreclosures and Overall Price Declines.”
The chart shows foreclosures are sold at prices 30 percent less than normal sales. Hence for every 10 percent rise in
the share of foreclosure sales, the overall price of all sales will be 3 percent lower than it would be without
foreclosure sales. Thus, if foreclosure sales reached 40 percent of all sales, the overall price of all sales would be
reduced by 12 percent below normal sales (3 percent times 4). The Case-Shiller Index shows that home prices of
all homes sold from the fourth quarter of 2007 to the first quarter of 2008 declined by 12.06 percent. That drop in
the overall price could have been caused by a rise in the share of foreclosed sales in all homes, rather than a
genuine decline in actual home prices, including prices of normal (non-foreclosed) homes sold. This assumes that
foreclosed sales are discounted 30 percent below normal sales.
One thing to note here is that I believe a Lack of Demand and High Levels of Forclosures are two sides of the same coin and therefore both CRTIRICAL to current market conditions. Also i feel his Minor rating for inacurate indicies is underestimated consitering these values are improperly used by the appraisal institute/foundation on a regular basis, it to should have a CRITICAL rating. In the final analysis what we have learned is that during any period of time there may be numerious markets, but always two, a Normal/Fair Market, and a Distressed Market, and for sanity and economic reasons they SHOULD NEVER BE PRECEIVED AS ONE OR “BIFORCATED!”
Curtis D. Harris, BS, CGREA, REB
Bachelor of Science in Real Estate, CSULA
State Certified General Appraiser
Real Estate Broker
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