Mastering Market Literacy

by Steve Cook on July 20, 2016

Housing Market JengaPerhaps the most valuable lesson that real estate consumers learned from the housing crash was that home values can fall as well as rise.  More than seven million families lost their homes to foreclosures and short sales; a brutal wake-up calls that though homeownership is safer than most investments it still involves risk.  Today’s buyers are very aware that a single wrong decision or factors beyond their control can cost them dearly.

That is one reason 90 percent of today’s buyers think it is very important to have an agent with knowledge of the real estate market.[1] Successful listing presentations and CMAs are rich with local data and analysis.  Agents who demonstrate a fundamental understanding of local market trends win more business and become trusted advisors because their knowledge.  Market “smarts” have become an important marketing strategy.  More and more agents and brokers as well as real estate websites, appraisal companies, franchisers and data analytics firms use the latest data to publicize market trends as a way to communicate their expertise.

You do not need a degree in economics to become market-literate, just an understanding of how local real estate economies work, fluency with the terminology and good sources for local data on sales, prices, values, and inventories.  Add your professional expertise and your skilled observations of the latest trends in the charts and numbers and you have a winning formula.

The Basics: How Real Estate Markets Work

Ideally, real estate markets follow the laws of supply.  If the supply of homes for sale is greater than demand, the market will put pressure on prices to fall until supply and demand come into as because buyers take advantage of bargains and fewer sellers list their homes Home will take longer to sell.  Should the supply of homes for sale be too small to meet demand, homes will sell faster, and prices will tend to rise until more sellers list their homes and buyers wait for better prices.

So the numbers of homes for sale, or inventories, and demand are the two keys to understanding how sales and prices are behaving and will continue to act shortly.  Demand is driven by changes in local household population; local income and employment levels; interest rates that make mortgages more or less expensive; accessibility of mortgage credit; and local rents.  Supply is created by move-up buyers, who also contribute to demand by buying a new home; by new home construction; by seniors and other owners who sell to become renters; by owners who relocate to another market; and by deaths.

In the real world of real estate, the rules of supply and demand do not always work well.  Sellers sell for many reasons, and most of them do not have much to do with higher prices—relocation, family and financial crises, they owe too much on their existing mortgage, or they need more space or to downsize now no matter what prices are doing.  Buyers often can’t take advantage of lower prices because they do not have the down payment, or they cannot sell their current to move up to a larger one. It is no wonder that the average American family sells a home only once every nine years.[2]

Because of the difficulties buyers and sellers have responding to market opportunities such as rising prices or a plentiful selection of homes for sale, real estate is considered a less “liquid” asset than securities, collectibles, precious metals and most other investment options.

The Fine Points:  Why Real Estate is Different

Illiquidity is just one of several significant ways that make real estate markets work differently than other markets.  Here are some others.

Seasonality. Home sales vary by the season, especially in northern climates where inclement weather makes it difficult to sell a house.  Sales rise in the spring and decline in the fall.  Therefore, comparing sales and prices on a month-to-month basis can be misleading. That is why home sales and prices are either “seasonally adjusted” with mathematical formulas that account for seasonal changes or are compared to a year over year rather than a month over month basis.

The Housing Ladder.  Only in real estate does a sale create a new buyer, as it does with a move up buyers.  Real estate works like a ladder.  As seniors downsize or die, they create new supplies for move-up buyers, who in turn create new supplies for first-time buyers.  That is why first-time buyers are so important; the housing ladder does not work unless first-time buyer demand is high enough to absorb the houses that move up buyers want to sell so that they can then buy a larger home.

Financing.  About half of all homeowners have a mortgage and 86 percent of recent buyers financed their home purchase with a mortgage.[3] The ability to qualify for a mortgage and the amount a mortgage will cost the borrower have an enormous impact on housing demand.  Factors like interest rates, lending standards that set requirements for income, debt and credit history and the availability of mortgage credit can affect demand for homes by making it easier or harder for buyers to get financing.  Currently, about three-quarters—62—of applications for mortgages to buy a home are approved.[4]

Hyper-locality.  There is no such thing as a national or a state-level real estate market.  Real estate is the most local of investment assets, yet market trends are most often reported and discussed regarding the nation as a whole, states or MSAs.  These are not markets; people buy homes on a house-by-house or neighborhood-by-neighborhood basis.  The numbers you see on the national news are mathematical calculations of millions of homes and thousands of monthly transactions; they are several steps away from what’s going on in a local market.  Local market conditions can vary greatly, even within a metropolitan area.  The factors that impact local values—transportation, retail, schools, taxes, economic conditions, open spaces, location, municipal services, safety, lifestyle—are local, even hyper-local.  A thorough knowledge of hyperlocal market trends is one an essential competency that distinguishes top agents and brokers.  However, market level data on a hyperlocal level is harder to obtain than so-called “national” data (see section on Market Data Resources).

Price is Different from Value.  The adage that “something is worth what someone will pay for it” doesn’t apply to real estate.  Instead, a home is worth what an appraiser says it is.  Why? Because nearly nine of ten homes are financed by a mortgage and lenders will lend no more than what an appraiser says a house is worth.  If the contract price is higher than the appraised value, the buyer, and/or seller must figure out how to make up the difference or the deal is dead.  Appraisal issues kill about 11 percent of sales today.[5]   One way to think about the difference between price and value is longevity.  Prices reflect temporary shifts in supply and demand—like tight inventories or heightened demand due to low-interest rates.  Values are more long-term and change slower than prices.  However, price changes DO change values over time because appraisers use prices or sales of comparable homes during the previous six months to make an appraisal.  As more homes in a market are appraised, recent sale prices will change values.

Every house has a unique value and responds differently to market changes.  In today’s market, sellers should price their homes very carefully and research local conditions to avoid overpricing that could lead to an extended time on market in case prices do decline.  Buyers and investors should be careful to avoid buying a home that is on the verge of losing value.  Determining an individual home’s value is difficult.  The “find your home’s value” calculators can be highly inaccurate, and they often mislead buyers and sellers.  New “Big Data” databases with hard sales data from millions of homes are more accurate but like all computerized valuations they may not reflect improvements and condition.

Medians and Averages.  A median is that value where half the numbers are lesser, and half are greater.  In real estate, the median is the price where half the homes sold that month were cheaper, and half were more expensive. An average is the total of those numbers divided by the number of items in that set. An “outlier”, or a value much higher or lower than the others in a group, changes the average but not the median.  Medians are preferred in real estate because they give a better idea of where the middle of the market lies.

Vocabulary: The Language of Housing Markets

Some agents are put off by the terms used to describe market trends.  Here is a short glossary of some of the most technical terms.

Affordability.  Several organizations, including the National Association of Realtors and RealtyTrac, Zillow, measure housing affordability differently.  All of them compare sales prices with income levels to determine whether local market trends are making it easier or harder for families with median income levels to buy a home.

Buyers’ and Sellers’ Markets.  A buyer’s market is one in which there are more sellers and homes for sale than buyers. Since supply is greater than demand, homes will be lower priced, making them more attractive to buyers. In a seller’s market, there are lots of buyers and relatively few homes for sale, which leads to multiple offer situations.

Comparative Market Analysis (CMA).  A CMA is an evaluation of similar, nearby, recently sold homes (called comparables). Comparative market analyses establish an estimate or range of current market value of a home. A comparative market analysis is not the same as an appraisal, which is performed by a licensed appraiser.

Capitalization or Cap Rate.  A ratio used to estimate the return on investment of a real estate investment property, it is calculated by dividing the income a property will generate in a given year (after fixed and variable costs) by the purchase price or current value of the property. For example, a foreclosure that sold for $50,000 and generates $40,000 in income after expenses per year has a capitalization rate of 80 percent.

Days on Market or Days on Site.  These are lengths of time a listing has been on an MLS or aggregated Website like Zillow or Realtor.com.  As a market-wide measure of supply and demand, many economists prefer Months Supply because it is less seasonal.

Equity.  Equity is the amount of a home’s value that the owner owns, calculated by taking the current value of the home and subtracting the amount the owner still owes on the mortgage loan. In practical terms, the equity is the sum of money one would get from the sale of a home after paying off the bank or the amount an owner can use as collateral for a home equity line of credit.

List Price, Contract Price and Sold Price.  A list price is a seller’s asking price when his property is listed on an MLS. A contract price is a price a seller and buyer on which sellers and buyers initially agree, but can change by the time of closing.  Sold price is the final price after closing.

Months Supply. This is a measure of the balance between supply and demand in a market over a specified period.  It is a calculation of the number of months it would take to use up all the current inventory of homes for sale at the current rate of sales.

Price to List Ratio.  This ratio is determined by the sold price divided by the last list price expressed as a percentage to show how much the final price differs from the seller’s asking price.  It is a measure of supply and demand. Should the ratio exceed 100 percent, sellers are getting more than their asking price.  If the ratio is decreasing, sellers are making greater concessions to buyers.

Resources:  Where to Find Market Data

MLSs.  Many MLSs aggregate data from their database and local monthly reports to their broker members.  Some also release them to the news media through their member boards.

MLS Data Providers.  Companies like RBI, CoreLogic, Terradatum and others provide monthly local market reports that are available to members on a subscription basis.  Some contain charts and tables you can use in CMAs and listing presentations.

National Web Sites.  Realtor.com, Zillow, and Redfin provide local market data on inventories, sales and prices, updated monthly.

National Association of Realtors. NAR provides free to its members quarterly local market data on sales and prices in 170 markets.

Leading Analytics Firms.  Companies like CoreLogic, RealtyTrac, Clear Capital, Pro Teck, Property Radar, Local Market Monitor and others provide data by markets and Zip codes on a subscription basis.

Valuations.  In addition to the calculators on a number of real estates websites, Weiss Analytics provides a projection on a property’s valuation trend.

[1] NAR Profile of Home Buyers and Sellers, 2015.  Pp 71. http://www.realtor.org/reports/highlights-from-the-2015-profile-of-home-buyers-and-sellers

[2] http://www.realtor.org/reports/highlights-from-the-2015-profile-of-home-buyers-and-sellers

[3] Ibid

[4] http://www.elliemae.com/origination-insight-reports/Ellie_Mae_OIR_MAY2016.pdf

[5] http://www.realtor.org/reports/realtors-confidence-index

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