Real Estate: The herding effect in home sales

From cows to cape cods, there's also a herding effect in home sales. People always find safety in numbers, and when homebuyers sense a change in direction the psychological shift in attitude can have a rapid and dramatic impact on home sales. Events can shape market trends, but just like the cattle drive crew, a small group of respected opinion makers can also have a considerable influence. When it comes to the housing market, one of the most highly respected tracking methods is the Case-Shiller Home Price Index. Standard and Poors provides this description of the index: "The Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family homes re-sales, capturing re-sold sale prices to form sale pairs. The index family consists of 20 regional indices and two composite indices as aggregates of the regions."

Shiller has been busy of late in the talk show circuit, because his carefully watched index recently made news by recording the first quarterly increase for home prices in the last three years. After a long ride up, followed by a long ride down, the index has finally turned the corner with an increase from May to June. Out of the 20 major markets, only Detroit and Las Vegas continued to see prices fall in June. As the graph shows, our local D.C. market actually experienced an upswing earlier in the year. For that market, prices have been on the increase since March. We make note of this because the Case-Shiller index is so highly regarded that it can inspire the herding effect and set us off in a new direction. The index is imperfect and sometimes criticized because it only looks at major metropolitan areas. But we consider it a pretty good barometer of the market as a whole.

Despite the encouraging data, Shiller is a scholarly guy with a Ph.D. in economics from MIT, so he's not prone to emotional overreaction. Shiller wrote a book titled "Irrational Exuberance," a term first coined by Federal Reserve Chairman Allen Greenspan in his description of the overheated "dot com" economy in the mid to late '90s. There was even a second edition to the book "Irrational Exuberance", so it shows Shiller is not one prone to ring the all clear unless the numbers clearly make the case. Additionally, a one month change in the index does not make a trend. But, after three years of declines, it does make news. Plus, the anecdotal experiences we have in our own office would seem to be consistent with the macro-economics of the Case-Shiller Home Price Index. Just by the number of showings we see on homes and the number of contracts being written, it would appear that we're coming out of the trough. Nevertheless, there's a lot of economic turmoil out there, and Shiller warns that substantial uncertainty still lies ahead.

Still, we wouldn't be surprised to see the housing market show some real signs of life as we move out of the summer doldrums and into the fall. If housing prices show some evidence of recovery, lenders may begin to relax loan requirements and the need for large down payments. This, coupled with an improving stock market and a reduction in housing inventories, could further fuel home sales. And due the herding effect, if people start to sense that they're missing the bottom, they may begin to really rush in, hoping to get on board before this train leaves the station. However, the recent recession has burned people in a way unseen since perhaps the great depression. As a result, we expect a good deal of caution, especially when it comes to big purchases like a house. With cash for clunkers, people are willing to put their toe in the water on buying a new Toyota Corolla. But laying out 400 grand on a new house is a little different.

We'll keep an eye on future changes in the Case-Shiller index and let you know if the numbers keep pointing up. Importantly, this index is not prone to head fakes or unwarranted changes in direction. The three consecutive month-to-month increases recorded for the Washington D.C. region are a good sign and point to a possible recovery that could be ahead of the nation as a whole. We'll keep you posted.

Tip of the week

When you're in a housing market where prices are on the mend, remember that homes sold in the past can be less relevant in determining the current value of property. Sellers have been pretty beat up for a long time, and as the market improves, they're going to hang tough a little bit more on...