SuperFreakonomics on Realtors

Still Casting Stones . . . But Now With (Lots of) Caveats

An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.

—Laurence J. Peter

[Editor's note: to see my rebuttal to Freakonomics, the predecessor to SuperFreakonomics, click here]

So, I finally finished off the (surprisingly short) section on Realtors in SuperFreakonomics.

Two things jumped out at me: 1) the authors, both economists, clearly have bored with attacking Realtors, and have moved on to other, fatter targets; and 2) they still think people who hire Realtors (as opposed to selling their homes themselves) are idiots, but this time they offer a lot of caveats.

Five, to be specific.

Here they are (my commentary follows in italics):

One. Even though Realtors don't do anything you couldn't do -- this seems to be the authors' mantra, by the way -- you still may want to hire one, anyway, if you don't have the time.

I spend anywhere from 40 to 100(!) hours per listing professionally staging my clients' homes, advising on disclosures, putting together professional marketing materials, doing pre-list networking -- and literally 37 other things.

And that's before their homes ever come on the market!

The professionals (and non-professionals) I work for would literally have to take a leave of absence from their day jobs to do what I do. Assuming they knew how.

Which leads to Caveat #2 . . .

Two. "Realtors don't do anything you couldn't do for yourself."

Oh, really? I've been selling real estate for almost 9 years. Before that, I was a corporate attorney and CPA, and have a Stanford economics degree. I have been successfully buying and selling stocks since I was 12 years old, and have started 3 companies.

I say none of that to brag (OK, a little), but to make the point that I'm not a dummy.

And yet every deal I do -- and I've now done about 70 -- I invariably learn something new.

It can be a contractual fine point; a negotiating insight; some arcane feature of a home that comes up on inspection; or even something as simple as "upgrading" to an especially talented, new photographer I heard about through the grapevine (in real estate like other fields, "who you know" can matter as much as "what you know").

The bigger point?

Suggesting that a novice could handle all the phases of a real estate transaction as expertly as a seasoned Realtor can is: a) uninformed; and b) insulting.

How much better?

It depends on the deal, the market, and who the ultimate Buyer is (assuming that I'm the selling, or listing agent).

But industry statistics (and common sense) suggest that the swing between having superior counsel and none at all (or poor counsel) easily exceeds 10%.

Which makes my commission -- substantially less than that -- a bargain.

Three. Madison, Wisconsin -- the market the authors cite as evidence that FSBO ("For Sale by Owner") Sellers do as well as Realtor-assisted ones -- may not be representative (call it the "your mileage may vary" caveat).

Yuh think!?!

Madison is a highly educated, college town with a metro population just over 200,000. It is about as representative of broader America as Manhattan is -- or Hollywood.

Notwithstanding Madison's experience with FSBO's, no other metro area has followed suit.

And even in Madison, FSBO's only account for 26% of home sales. That means almost three-quarters(!) of all homeowners there still list with traditional brokers.

In my experience, if something truly is a "better mousetrap," sooner or later people tend to discover it . . . and switch (assuming they have a choice, i.e., there's no monopoly provider).

Instead, FSBO's are now declining as a percentage of the market place nationally (about 12%).

Four. Self-selection. Or, as the authors put it, "the kind of people who choose to sell their own houses without a Realtor may have a better business head to start with."

At least in my experience, that statement is categorically wrong -- which, ironically, actually supports the authors' argument that FSBO's can do better, net of commission, selling themselves.

From what I've observed, what invariably characterizes FSBO Sellers isn't a "better head for business" -- it's a simple (if uninformed) desire to net more on the sale of their home, coupled with having some "extra time" on their hands (in economic-speak, their perceived "opportunity cost" is low).

Unfortunately, the vast majority of FSBO's don't have a clue as to how to go about doing it.

So, something like 9 out of 10 FSBO's egregiously overprice, while the 10th literally gives their home away (then brags that they "sold without a Realtor").

Which gets to caveat #5 . . .

Five. The authors' data and conclusions may be flawed.

To recap, the authors allege that Realtors selling their own homes (vs. clients') are more patient waiting for a deal, and (therefore) sell for more. They base that conclusion on a study of 100,000 homes sales in suburban Chicago -- 3,000 of which were sold by owner-agents.

Charge #2 is that FSBO Sellers fetch the same price that Realtor-listed homes do -- they just take a little longer (20 days on average) to sell. That's based on the aforementioned study of FSBO Sellers in Madison.

I couldn't find the Chicago study the authors refer to (anyone who knows, please feel free to point me in the right direction).

However, the study of FSBO Sellers in Madison was conducted between 1998 and 2004 -- a Seller's market there (and most of the rest of the country, too).

I doubt that FSBO sellers in Madison today would fare nearly as well.

Meanwhile, the authors' contention that more market time equals higher price contradicts what I've observed over thousands of deals covering the better part of a decade -- namely, the longer a given home is on the market, the lower the selling price. Period.

And that relationship holds whether the Seller is an owner-agent, a FSBO . . . or the man from Mars.

But the most significant weakness in the authors' argument is their assumption that it's possible to isolate differences between Realtor and non-Realtor sold homes by "carefully controlling along several dimensions -- price; house and neighborhood characteristics; time on market; and so on."

Unfortunately, that's notoriously difficult to do in practice.

Precisely to avoid such an "apples-to-oranges" problem, the housing market's leading price index, Case-Shiller, opts in favor of tracking "sale pairs" -- the same home across multiple transactions.

Echoes of Peter Lynch

The arguments in Freakonomics and now SuperFreakonomics ultimately recall Peter Lynch's best-selling book, "One Up on Wall Street," in which Lynch disingenuously tells retail investors -- "Mom & Pop" types -- that they can outsmart the pro's.

How?

By following their spouses and kids to the mall, being the first to notice the hot new, retail trends, then buying the companies positioned to profit.

Unfortunately, for every Apple Computer discovered that way, there are 10 -- or 100 -- "Krispy Kremes" (busts, flame outs, and one-hit wonders).

What Lynch omits is that, in his hey day, he traveled 300-plus days a year, personally talking to senior managers at thousands of companies; checking out their facilities; quizzing their employees and competitors; and relying on a battery of Fidelity analysts to analyze thousands of companies' financial statements.

Level playing field, indeed.

"If You Don't Know Who the Patsy Is . . " *

The authors of Freakonomics (and now SuperFreakonomics) perpetuate the same myth about real estate -- namely, that amateurs who do their homework can outsmart the pro's.

Who ultimately profits from that misconception?

Just as in the stock market, in the housing market the beneficiaries are the pro's on the other side of the transaction.

So, on behalf of Realtors everywhere, I suppose I should say: 'Thank you, Freakonomics!'

*It was Warren Buffet who said, "if you've been playing poker for 30 minutes, and you don't know who the pasty is . . . it's you."

Changing Sales Mix Blurs Housing Price Changes

2010 Housing Market:
More Toyotas (er, Chevy's), fewer BMW's

Confused by the cacophony of statistics purporting to describe today's housing market?

The root of the problem is that the statistics are really capturing two things: 1) the change in housing prices; and 2) the changing mix of homes that are being sold.

(The exception to the foregoing is the Case-Shiller index, which purports to isolate factor #1, changing prices, by only looking at "matched" sales pairs -- that is, the same house. However, Case-Shiller is susceptible to other weaknesses, at least in my opinion.)

Chevy's vs. BMW's

To illustrate the problem, imagine if auto sales were measured the same way as home sales.

In a recession, people buy more, uh . . . Chevy's; in good times, more BMW's and Lexuses.

That doesn't mean auto prices fall dramatically in a recession -- it means that economy cars are more popular.

Similarly, when bank-owned foreclosures dominate the housing market -- like in 2009 -- the "average" and "median" home selling prices fall, too.

That doesn't necessarily mean that home prices have dropped dramatically.

Rather, it means that smaller, less expensive homes are . . . smaller and less expensive.

Raw vs. "Massaged" Real Estate Data

City Lakes November Showings

It's easy to get overwhelmed by real estate statistics -- even for professionals.

For starters, there's monthly sales data; "pending" sales data (under contract, but not closed); median and average sale prices; number of active listings (inventory), etc.

Those data are available locally, regionally, and nationally.

Further complicating matters: different "scorekeepers" use different formulas.

Case-Shiller, perhaps the best known index, uses a methodology called "matched pairs" to track monthly price changes in the 20 largest metropolitan areas.

By contrast, the National Association of Realtors and various government agencies track more markets nationally, but typically focus on less expensive homes financed with smaller, "conforming" loans (under $417k in most markets).

Some of the foregoing seasonally adjust their data, some don't.

Finally, the housing market is really two markets: existing and new construction (the former is about 10x larger).

New construction has its own tracking bodies and vocabulary, including "permits issued," "housing starts," etc.

No wonder getting an accurate picture of the housing market is like the blind men and the elephant: each one's take . . . depends on their perspective.

Focus: "Micro," Raw Numbers

So, how do you cut through all that complexity?

By getting back to basics -- specifically, by focusing on raw (vs. seasonally adjusted) data, at the local level.

It doesn't get any "rawer" or more local than showing statistics.

A "showing" is nothing more than a prospective Buyer -- accompanied by their Realtor -- viewing a home that's for sale.

In my experience, only about 10% of first showings ultimately lead to a closed sale. However, if you're home isn't getting shown . . . your chances of selling are effectively 0% (my clients all know my line about "if your parents don't have children, you won't either").

In early August, showings for my office, Edina Realty City Lakes, hit a peak for the year at 332. By contrast, the week before Thanksgiving, that number was 94 -- a drop of more than 2/3 (Thanksgiving week, it was even lower, at 60 showings).

Parsing the Numbers

What's the likely explanation?

Early August was when serious Buyers "had to get a move on" to learn the market and close before Nov. 30 -- at the time, the deadline for using the $8,000 tax credit.

When the tax credit was extended and expanded a few weeks ago, traffic fell off even more than normally happens in late Fall.

In truth, the drop-off isn't quite as bad as it looks.

The reason is that Buyers out looking now are typically more serious, whether because of job transfers, expiring leases, etc.

Call it "quality over quantity."

May '09 Case-Shiller Stats

Market Snapshot: Case-Shiller vs. Ross Kaplan

According to the just-released S&P/Case-Shiller home-price index, Minneapolis home prices rose 1% in May. If you like raw statistics, the May number was 109.77, vs. 108.51 in April.

Notwithstanding the "scientific" ring of such precise numbers, my Realtor's, "boots-on-the-ground" take is that things are much more amorphous.

Here's what I can confidently report as of late July:

--the window for getting a great deal on a foreclosure is closed, at least for now. The supply is down dramatically, and anything priced below market routinely draws multiple offers, negating whatever discount there may have been.

--the top end of the Twin Cities market -- high six figures and above -- remains very soft, with supply approaching almost 3 years.

--Overall Twin Cities inventory has quietly shrunk, from a peak of 34,000 units, to about 23,000 units now. Given that a balanced market is high teens, and a Seller's market mid-teens or lower . . . downward price pressure has clearly abated. In other words, we're bottoming (I do believe the Case-Shiller numbers are correctly reflecting that).

--That said, the "wild card" now isn't supply, but demand. Specifically, stuff like wages, jobs, and consumer confidence. The Buyers I'm working with are pleasantly surprised by their choices, but still quite cautious.

As I've previously written on this blog, the "one-size-fits-all" approach to the local housing market obscures lots of nuances.

Sold . . in 7 days!

Where: 2600 Inglewood, in St. Louis Park's Fern Hill neighborhood

What: 3 BR/2BA Georgian Colonial with just under 2,000 FSF

How Much (Asking Price): $374,900

When: May, '09

Who: Ross Kaplan, listing agent

Case-Shiller may show that the Twin Cities dropped 6.1% in March, but that didn't stop this handsome Colonial from selling quickly (technically, it's "Pending" or under contract; the actual closing date, which is when title transfers, is still a month away).

In the real estate equivalent of "build it and they will come," if you prep well, price it right, stage carefully, and market aggressively . . . it will still sell.

Pioneer Press article

Local Reaction to Case-Shiller Numbers

Apparently, Case-Shiller's March statistics showing a 6% drop in Twin Cities house prices provoked a range of reaction, including some questioning its accuracy.

Chris Snowbeck's piece in the St. Paul Pioneer Press today, "Home Prices Dive -- With an Asterisk," does a nice job cataloguing the responses (including a quote from yours truly). According to Snowbeck, "reaction to the Case-Shiller numbers ranged from skepticism to indifference."

My take definitely places me on the "indifferent" end of that scale, for the reasons I mentioned on this blog yesterday . . .

Latest Case-Shiller Numbers

"Are the Case-Shiller Numbers Right?"

Chris Snowbeck at the St. Paul Pioneer Press is soliciting local Realtor and lender feedback to the latest Case-Shiller housing statistics. The (absymal) March numbers showed a record one-month fall of 6% in the Twin Cities.

Snowbeck's question to the "experts" (myself included): 'are the Case-Shiller numbers accurate?'

Here's what I emailed Snowbeck:

My main reaction is that a market-wide statistic simply isn't that useful, no matter how accurate it is. The Twin Cities housing market, to me, is at least 90 discrete sub markets; even Minneapolis has thirty-plus separate neighborhoods (and 11 separate areas for MLS purposes).

I don't doubt that the neighborhoods where foreclosures are running rampant -- Jordan and Folwell in Camden; Phillips; parts of Powderhorn -- are down much more than 6% in March. However, near Linden Hills, parts of Seward, and near Cedar Lake are doing fine.

The 6% is a blended number, that masks huge variances . . .

Watch for Snowbeck's article tomorrow(?) . . .

Real Estate "Upticks" & "Downticks"

Divining the Direction of Housing Prices,
One Deal (and Tick) at a Time

Both the stock and housing markets have "upticks" and "downticks."

The difference is that, in the stock market, ticks are measured in pennies, whereas in residential real estate, they're measured in thousands -- or even tens of thousands -- of dollars.

For the uninitiated, a "tick" is simply the difference between the current selling price and the last selling price.

So, if the last trade for Microsoft stock was for 1,000 shares at $19.62, and the trade before that was for 500 shares at $19.61, it's selling at an uptick.

In the housing market, the equivalent is a home that sells faster, at a higher price, than its peers ("comp's," or comparable sold properties).

What difference does any of that make?

While you can't tell where the broader housing market is going, at least at the "micro" or neighborhood level, it's possible to tell whether housing prices are headed up or down at the moment by looking at the direction of the "tick's."

In fact, that's how good Realtors recommend their clients price: they know the inventory in a given neighborhood cold, and can tell whether the trend is up or down (news flash: clients don't always heed their Realtors' advice).

If the last few ticks have been up, the next homeowner has leeway to price more aggressively; down, the reverse.

I'd go even further: three consecutive "upticks" signals a rising market.

Notwithstanding the latest, gloomy Case-Shiller numbers (for February, covering the Twin Cities market as a whole), in several local neighborhoods this Spring, there are now a string of sales at consecutively higher prices.

December Case-Shiller Numbers

December S&P/Case-Shiller:
Minneapolis Down 18.5%

The latest S&P/Case Shiller numbers (for December) are out, and to no one's surprise, they're dreadful: all of the nation's 20 largest housing markets show decreases, from the merely bad (Dallas, Denver) to the shocking (Las Vegas, Phoenix).

Minneapolis shows an 18.5% drop from a year earlier.

Before you jump to the conclusion that this is dramatic new evidence of market deterioration, keep in mind two things:

One. Case-Shiller is a month behind other housing statistics. Locally, the Board of Realtors is already reporting January sales activity.

Two. Foreclosures are now dominating sales activity in many markets nationally, including the Twin Cities.

Foreclosure are not exactly known for being in pristine condition, or located in the toniest neighborhoods.

As I've blogged previously (yes, it's turned into a verb, like "Google"), when consumers all switch to buying $1.89 gallons of milk at Wal-Mart from $3.49 gallons at "Deluxe Groceries," it doesn't mean that the price of milk has dropped 46%. Rather, the product mix has changed.

That's equally true in today's housing market.

Underwater Mortgages: How Much?

Underwater . . vs. Drowned

According to The New York Times, "about $500 billion in mortgage debt is already underwater" ("Bailout Likely to Focus on Most Afflicted Homeowners"). That's realtor-speak for a house being worth less than the mortgage against it.

Unfortunately, based on my calculations, that number appears to be conservative.

Using industry statistics, and a blend of various housing price indices (National Association of Realtors, S&P/Case-Shiller, etc.), I estimate that more than $540 billion in mortgage debt nationally is now underwater. Of course, that number continues to rise as home prices fall.

Here is the math, along with the underlying assumptions (downpayments are presumed to rise steadily from 2006, as lending standards tightened; homes sales include both new and existing):

2006

Home sales (units): 6.5 million

Sale price (ave.): $250,000
Down payment (ave.): 5%
Mortgage (ave): $237,500
2009 market value: $187,500
Amount "underwater" (ave): $50,000
Total -- all homeowners: $324 billion underwater

2007

Home sales (units): 5.7 million

Sale price (ave.): $233,000
Down payment (ave.): 7.5%
Mortgage (ave): $215,525
2009 market value: $187,500
Amount "underwater" (ave): $29,125
Total -- all homeowners: $165 billion underwater

2008

Home sales (units): 4.9 million

Sale price (ave.): $220,000
Down payment (ave.): 10%
Mortgage (ave): $198,00
2009 market value: $187,500
Amount "underwater" (ave): $11,000
Total -- all homeowners: $54 billion underwater

Underwater mortgages - Total: $543 Billion

As the foregoing shows -- and the chart illustrates -- the closer to the 2006 peak one bought, the further underwater they are.

To round out the picture, some further tweaking is necessary.

Specifically, add: 1) the "pre-peak" home buyers in 2004-2005 who still caught some appreciation, but who lost that (and more) in the subsequent decline; and 2) all the homeowners who borrowed against their homes via home equity loans and cash-out refinancings.

The main subtraction would be the three million-plus homeowners who've already lost their homes to foreclosure. According to Moody's Economy.com, foreclosures could swallow another five million homes the next three years.

If so, that will certainly reduce the number of underwater mortgages -- but only because a corresponding number of homeowners will have drowned.

Nov. - Dec. Housing Statistics

Foreclosures Explain Latest
Housing Price Drop

The most recent batch of housing statistics -- from S&P/Case-Shiller and NAR -- show that housing prices are continuing to fall nationally. Depending on how you slice and dice the market (sale pairs, top 20 markets vs. all markets, all homes vs. those under $417k, etc.), the year-over-year annual decline ranged from 13% to 18%. Nationally, the cumulative decline from the 2006 peak now is about 25%.

As a boots-on-the-ground realtor, mostly what I'm seeing is that the activity is at the low end of the market, specifically in foreclosures. Locally, lender-mediated transactions (foreclosures and short sales) now account for a staggering 40% of Twin Cities housing transactions.

What market-wide statistics obscure is that there's a disconnect in the pricing of foreclosures, and "traditional" sales.

Depending on the condition, foreclosed properties can sell for discounts of as much as 50%-75% from what they'd fetch in "mint," move-in condition. On top of run-of-the mill neglect and dated features, many foreclosed homes have freeze damage (busted pipes and radiators), no functioning heat, numerous code violations, and a trail of tax and third party liens. It's also the case that they are overwhelmingly concentrated in what were already lower-priced neighborhoods to begin with.

Compounding matters further (if that's possible), most banks won't lend on condemned homes (automatic with no heat). That means that prospective Buyers must hunt for a bank that will, or pay cash. Then, they must figure out how to finance all the aforementioned repairs and updates.

When everything is said and done, the home's purchase price can be little more than a down payment on all the post-closing expenses to come.

How much of a discount would you need to take on such a project??

At this point in the downturn, more and more transactions meeting the foregoing description are being mixed into -- and driving -- the housing statistics regularly being reported by the media.

If you separated the foreclosure sales from the non-foreclosure sales, you'd undoubtedly find that the former dropped much more than 17%, while the latter dropped much less.

P.S.: I discuss the "bifurcated market" phenomenon more fully in two other posts, "Housing's Wal-Mart Effect" and "A Tale of Two Markets."

Insuring Against Dropping Prices

Want to Entice Home Buyers?
Insure Them Against Losses

Stock market investors who believe prices are low, but not certain they have bottomed, can hedge their bets by doing what is called "dollar cost averaging." By committing fixed amounts of capital at regular intervals, they are guaranteed to accumulate relatively more stock when prices are cheapest.

No doubt one of the problems exacerbating the drop in real estate prices nationally is that there's no equivalent strategy for prospective homeowners: you either buy, or you don't buy.

If prices are falling nationally at an accelerating rate, as the latest Case-Shiller numbers indicate, it seems safer to wait until it's clear that they aren't. Of course, when all Buyers simultaneously do this, a "buyers' strike" results. That causes demand to vaporize, and a further drop in prices becomes self-fulfilling.

Interrupting this cycle should be a high priority for the Obama administration. Once buyers return to the housing market, price equilibrium will eventually follow. And once the housing market stabilizes, it's at least possible for the U.S. (and global) economy to begin to recover, as well.

Fortunately, there is a relatively cheap, innovative way to make buying a house in today's harrowing economic environment less like a leap of faith, and more like dollar cost averaging: government-sponsored home insurance.

Although severely tarnished by its association with AIG, the concept of insurance and risk dispersion has great social utility. People now insure against any number of events -- death, illness, unemployment, fire, etc. -- where the odds of occurrence are low, but the consequences if it does are financially catastrophic.

Surely the prospect of one's home losing tens (or hundreds) of thousands in value would qualify as a financial disaster, at least for most of us.

"Sauce for the Gander"

The solution is to allow (require?) new homeowners to pay a recurring premium on an insurance policy, written by the government, that would defray a significant percentage of any realized loss on their home. (Does the government guaranteeing against loss sound familiar? It's essentially the same tack that the FDIC uses to entice strong banks to buy the assets of failed banks -- or the Treasury and Fed used to get JP Morgan Chase to buy Bearn Stearns.)

To ensure the proper financial incentives and deter speculators, such government-underwritten insurance should have three features:

One. Ten percent deductible. Buyers who face no risk of loss have no reason to behave responsibly. Indeed, it would be rational to buy as much house as you could, because the gain would be yours, while any loss would be made up by the government (apparently, only Wall Street gets to play that game). If instead the first 10% of any loss was borne by the homeowner, that incentive goes away.

Two. Profit-sharing. To further deter home buyers looking for a quick score, the home price insurance policy should contain a reciprocal quid pro quo: the government is your partner, 50-50, on any gain. In fact, Stanford University has long used a variant of this policy to extend cheap financing to faculty buying (very expensive) Bay area homes. Stanford's gains on the "back end" defray much of the program's expense.

Three. One policy per household, non-assignable.

One of the reasons credit derivatives became the world's biggest game of fantasy football (Michael Lewis' characterization) is because investors didn't have to have an insurable interest to play. As Lewis puts it, "[credit defaults swaps] are like buying fire insurance on your neighbor’s house, possibly for many times the value of that house — from a company that probably doesn’t have any real ability to pay you if someone sets fire to the whole neighborhood." ("How to Repair a Broken Financial World," The NYT; 1/3/09)

The legal profession has long recognized the perils of such untethered speculation, and developed a concept, champerty, that prohibits uninterested third parties from buying stakes in other people's lawsuits.

The home insurance program needs a comparable policy: one person, one homestead, one home price insurance policy.

By its terms, government-sponsored home insurance would be self-sunsetting. That is, as risk-aversion in the housing market subsided, fewer people would feel the need for loss protection (and be willing to pay the associated premiums). In the meantime, many prospective home buyers clearly would be willing to trade a floor under their potential home losses for a ceiling (or at least a brake) on their prospective gains.

Critics will no doubt characterize such an insurance program as tantamount to fixing home prices, or at least setting a floor under them. In normal market conditions, that might be true.

However, the current housing market, characterized by paralysis and, at least in some markets, freefalling prices, is anything but normal. Under the circumstances, it is incumbent upon government to interrupt a particularly dangerous vicious cycle -- home price deflation -- before its momentum becomes even more difficult to break.

Recession Hits Housing Prices

Oct. Case-Shiller Numbers:
Down 18% from '07

“People who think they’re going to lose their job don’t buy a home”
--Steven Ricchiuto, chief economist at Mizuho Securities; NY Times (12/30/08)

There's not much mystery about the most recent leg down in the national housing market: recessions destroy jobs, and people who are unemployed -- or worry they may soon be -- don't make major purchases.

For most people, there's no bigger financial commitment than buying a home.