(This is Part 2 of a two-part series. Read Part 1, "Put a gag on Chicken Little.")
The Case-Shiller Index portrays itself as being "the leading measure of U.S. home prices," according to a Standard & Poor’s press release from April. Given how much press the index receives, it may very well be the leader — the leader in inaccuracy.
Last week’s article looked at the contradictory data from OFHEO (the Office of Federal Housing Enterprise Oversight), NAR and Realogy vs. the S&P/Case-Shiller Index. This week, we look at additional pitfalls that explain why the press should not rely exclusively on the S&P/Case-Shiller data.
1. Where’s the beef?
The S&P/Case-Shiller Index ignores huge chunks of data. Andrew Leventis, in a 2007 paper comparing the OFHEO approach to the S&P/Case-Shiller approach, explained the differences in the data in the following way:
"According to the methodology materials, the S&P/Case-Shiller Index does not include price data from 13 states. Market conditions in those 13 states have, on average, been stronger than in the rest of the nation. OFHEO’s estimates indicate, for example, that three of the five fastest-appreciating states in the nation (Idaho, Montana and Wyoming) do not have representation in the S&P/Case-Shiller index … The S&P/Case-Shiller index also apparently has incomplete coverage in 29 states."
I have to wonder how the public would feel about the "national numbers" that include no data for 26 percent of the states and only partial data for another 58 percent.
2. A bogus claim
The S&P/Case-Shiller index claims to have "100 percent coverage" in nine states. The claim of "100 percent coverage" is false. In the description of their methodology they plainly state:
"The S&P/Case-Shiller indices do not sample sale prices associated with new construction, condominiums, co-ops/apartments, multifamily dwellings, or other properties that cannot be identified as single-family."
The most extreme example of this lack of coverage and how critical is to correctly assessing the market comes from New York City. The S&P/Case-Shiller Index claims that prices fell 5.6 percent during the first quarter of 2008. According to David M. Michonski, chairman and CEO of Coldwell Banker Hunt Kennedy in New York City, however, "Condominiums and co-ops account for one-third of New York City sales and 99 percent of Manhattan sales. Thus, Shiller gives the impression of reporting that prices have dropped 5.6 percent in a place where he does not cover 99 percent of the sales and where prices have not dropped, but risen, substantially."
Michonski’s claim is based upon data from Miller Samuel, a highly respected appraiser who tracks New York prices. In a summary of activity in the first quarter of 2008, Samuel reports:
"The median sales price of a Manhattan apartment was $945,276, up 13.2 percent from the prior-year quarter median sales price of $825,000 and up 11.2 percent from the prior-quarter median sales price of $850,000 … Average price per square foot was a record $1,289 this quarter, up 20.5 percent from the prior-year quarter result of $1,070 and up 9.2 percent from the prior-quarter average price per square foot of $1,180 … The 10.8 percent increase in year-over-year quarterly median sales price is the highest increase since the third quarter of 2006 when the increase was 12.7 percent."
3. Buyers and sellers make "mispricing decisions"
According to the S&P/Case-Shiller pricing methodology:
"It is also assumed that two sale prices that make up a sale pair are imprecise, because of mispricing decisions made by home buyers and sellers at the time of a transaction. Mispricing variance occurs because buyers and sellers have imperfect information about the value of a property. Housing is a completely heterogeneous product whose value is determined by hundreds of factors specific to individual homes … The difficulty in assigning value to each of these attributes, especially when buyers and sellers may not have complete information about each factor, means that there is significant variation in sale prices, even for the homes that appear to be very similar."
How does the S&P/Case-Shiller approach address this challenge? They use a mathematical "weighting formula." Yes, you read that correctly. The S&P/Case-Shiller approach asks us to believe that buyers and sellers who have actually seen the houses and the neighborhoods are less accurate in their ability to price property than the mathematical formulas from Wall Street and academia. This is absurd. Lenders don’t look to computer-generated models to make lending decisions; instead they rely on those buyer and seller "mispricing decisions" (i.e. comparable sales) to determine how much they will loan on a given property.
4. Hedge your bet
Hedge funds use the S&P/Case-Shiller Index to allow investors to sell real estate "short." In other words, if you "hedge" a real estate investment, you are paid when the index declines in value. On the other hand, when prices increase, how much demand will there be for a financial instrument that reimburses you when property values decline?
Ultimately, the question is whom should you believe — the academicians and Wall Street with their complex derivatives that gave us the subprime mess, or NAR, the federal government and the real-world numbers from publicly traded real estate companies? I know whom I trust — how about you?
Bernice Ross, national speaker and CEO of Realestatecoach.com, is the author of "Waging War on Real Estate’s Discounters" and "Who’s the Best Person to Sell My House?" Both are available online. She can be reached at bernice@realestatecoach.com or visit her blog at www.LuxuryClues.com.
Ross will speak at Real Estate Connect in San Francisco, July 23-25, 2008. Register today.
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