Why Do Home Prices Move

May 15, 2013

Featuring Bill King, Director of Valuation Strategies

Monthly Podcast Transcript - Duration: 17 minutes

Adrienne Ainbinder, Moderator: Welcome to Veros Real Estate Solutions and our monthly podcast. Today I’m here talking with Bill King, our Director of Valuation Strategies. We’re talking about a concept that I think can really be taken for granted. The ultimate question today is why do home prices move and what makes that happen, Bill?

Bill King: Adrienne, thank you. To give this full treatment would certainly exceed what we can do in the context of this broadcast. This discussion would really require or a full discussion would require delving into what is value, how does value differ from price and cost and other concepts of that sought. And we would have to talk about why it’s important to even understand what those differences mean. But in order to try and answer this question in a relatively brief way, I think that there’s a couple of things that we do want to understand about what has happened in the relatively recent past, going back to the beginning of 2000.

As we all now know from the roughly 2001 period through about 2008, we saw a pretty rapid run-up in real estate prices that was followed by a rather significant financial crisis that included a lot of decline in real estate prices in most communities around the country. I think there are two significant things that happened in that period that helped fuel the run-up in prices. We had departures from reality in all seriousness. The first was that we really stopped paying attention to some basic economic fundamentals about housing prices and how housing prices move. In this period from about 2002 through 2008, prices moved based on noneconomic forces, traditional things that would impact real estate value were not the things that were driving the price changes that were occurring at that point. So if we looked at what was happening in wages, what was happening in rents, there was not a significant movement of those categories that would fuel demand for housing. We didn’t have significant shifts in population that would typically occur in response to employment opportunities. So the fundaments were just simply not there. Wages were not rising rapidly, rents were rising a little bit, but not enough to be a force, and as I say, population shifts were not occurring. So there’s another economic factor that we can point to as having been a significant factor in driving prices.

What did happen is - and the second thing that we really lost sight of - is that people were really reacting to interest rates. We had historically, gosh for all the time I’ve been in the business, 30-plus years, an interest rate of anywhere from eight or nine percent to as much as 11 or 12 percent prevailed through most of the last probably four or four-and-a-half decades. And all of a sudden interest rates started dropping; people started buying based on interest rate. So we had a lot of frenzy that started to occur around interest rates, so that sort of explains part of why we had the run-up. I think another factor that we didn’t really see for what it was worth at the time, is that with the frenzy, with the attraction, and the national attention that real estate prices and real estate activity was getting at that point, there were a lot of people who hadn’t previously been homeowners, who hadn’t previously been out in the market to buy a home who decided I better get in on this thing. There was some of that mentality that prices are going up and gee-whiz if I don’t buy today, I’ll never get in, so there were a lot of first-time buyers – a higher percentage of first-time buyers in the market at that point than there may have ever been before.

So these buyers come into the market, and in a lot of cases, they don’t have a big savings account. They don’t have a lot of resources available, and there was availability of financing to just about anybody. So they were able to get 100 percent loans, and what would typically happen is that they would look at a house that was available for sale and if a seller put his house up – if a seller had a house and said well, gee-whiz, I think it’s worth about $200,000, so I’ll price it at $205,000 or maybe even $210,000 to allow some room for negotiation. First-time buyer comes along and says gosh I’d like to buy that house and I don’t have a quarrel with $200,000 as value. I’m not even gonna have a quarrel with $210,000, but I’ll offer $210,000 and ask the seller to put $10,000 into my closing costs and maybe down payment assistance and help me get this deal closed. So from the seller’s perceptive they’re still getting their $200,000. The offer price looks at $210,000 and $10,000 goes into the buyer’s side of the ledger. So far so good. The sale closes and it gets recorded at $210,000. The folks down the street think maybe they want to sell their house, and they look up and say well gosh Bob and Mary got $210,000 for their house. I think our house is worth a similar amount. We’ll put ours on the market for $215,000 or $220,000 with that same idea. We’ll allow some room for negotiation and see what we can do, and another buyer comes along and they repeat the same exercise contributing to the buyer’s down payment, recording of a higher price of say $215,000. Part of the problem overall is that when the appraisers came into the mix to value these properties for these transactions, I think in a lot of cases there was a sort of lackadaisical approach to the traditional practice of verifying the terms and conditions of sales that are gonna be used as comparables. So the appraiser looks at the recorded price of $210,000 and uses that unadjusted as a piece of evidence for the appraisal. So we get this happening time and time again, and pretty soon we’ve bid these $200,000 houses up to $260,000, $270,000, $280,000, and it’s really been a sequence of failing to verify, failing to look at what the cash equivalent transfer price was, and little by little artificially inflating sale prices.

Adrienne Ainbinder: What about the practice bracketing and how does that influence this concepts of value movement?

Bill King: Sure. That’s a great question. Appraisers have been instructed for years and have what is perceived as a rigid requirement, but it’s certainly a preference and a guideline not necessarily a rigid requirement. But that is that when appraising a property, the features, and the price of the subject property should be bracketed by the comparable sales. Basically what that means is if I have a house that has 2,000 square feet, I want at least one of my comparable sales to have more than 2,000 square feet and one to have less than 2,000 square feet. The idea being that if we find properties that are slightly superior and slightly inferior and measure the pricing of those properties and make the appropriate adjustments, we’re gonna come up with a very reasonable and supported final value opinion for the property being appraised.

One of the things that lenders like to see bracketed is that unadjusted sale price. So if the transaction price for my subject property is $210,000, ideally I want to see a house more than $210,000, and maybe one that’s slightly less than $210,000 in that array of comparable sales. So the question that invariably comes up when we have this discussion is if I’ve always got to find a house that’s worth more or that sold for more than the one I’m appraising, how can prices ever move up? So in a reasonable market in an ideal set of circumstances what would happen is, for example, the house is priced at $210,000, and I agree to buy it for that. The appraiser comes in and can’t find a sale for more than $200,000, so the appraisal comes in at $200,000. As a buyer, if I look at that and say well I still want the house, and I still feel that it’s worth $210,000, I’m gonna take $10,000 more out of my savings account and put it into this house and we now close that sale. There’s a new benchmark for houses of that type at $210,000.

What distinguishes the process I just described from what was happening in the period from ’02 to ’08 is that money, that difference, that increase in price, came from an investment made by a buyer. Typically, it’s experienced buyers; it’s knowledgeable buyers who have been through the process before that make a decision to put an extra amount into the house they’re buying that constitutes the healthiest way for prices to move in the market. Again, part of the problem that we had in the last decade is the prices were moving up not because there was an additional investment being made by the buyer, but because there was an additional amount being thrown into the buyer’s side of the equation by a seller, and that amount wasn’t coming from the seller’s proceeds. In other words, their net equity position stayed unchanged compared to what they sought when they put the property in the market. All we did was increase the price to fabricate money into this transaction. We’re effectively pulling it out of the lending community and they participated.

Here’s an additional problem with that whole scenario and one that got covered up by the rapid rise in prices that went on for six or seven years. If I don’t have any money for a down payment, and I’m asking the seller to pay for most of my closing costs, I’m probably asking for all of that because I simply don’t have the money. So I move into this new house that I’ve just bought with virtually no reserve, and if the roof leaks, or the furnace quits, or some other major problem occurs with the house, I don’t have the money to fix it. And that is as often as not a prelude to default and ultimately foreclosure and many other major factors that contribute to default and foreclosure. So if I bought the house for $210,000, didn’t have any money, and 18 months later I have a problem, and I now can’t afford to keep my house. If it was 2004/2005 by $210,000 is now $250,000, $260,000, $270,000, prices went up that fast, I can sell it, cover the closing costs, the selling costs, and even still maybe have a few dollars to walk away with. So my mistake buying something I couldn’t afford has largely been forgiven by the market. By the time we got into 2008, all the forgiveness was used up and people were stuck, and that’s where we saw the wheels start to fall off.

Adrienne Ainbinder: So where we stand today what is your opinion about how prices are moving and are we in that territory where we’re moving up in a safe and respectable manner, or are there still some issues happening?

Bill King: Well, that’s a good question. I think that there is a little bit to be concerned about, but I think more of the buyers that are in the market today are not the uneducated first-time buyers. They have some experience, and my observation is that in some of the markets where we are seeing prices get bit up, just reminiscent of what we saw in the early part of the last decade, many of these increased prices are being paid in the form of additional down payments being made by experienced buyers. That’s good news. I am concerned about the number of people that are potentially buying based on interest rate. We are at truly historic lows. We’ve gotten to say that many times over the last ten or 12 years because we got into historic territory and have managed to stay there for some time. But we’re at an interest rate prevailing rate now for a 30-year fixed rate mortgage of about three-and-a-half percent, and a one percent rise of interest rates at this point would be about a 25 percent increase in the overall rate. I think we’d go into market shock if rates went up that quickly at one time, which would stall what’s going on out there right now. This little bit of recovery that we’re seeing is certainly a great thing, but I hope that it moves in a measured fashion and not too quickly.

Adrienne Ainbinder: Absolutely. I couldn’t agree more. Bill, I want to thank you for taking the time for shedding some new perspective on what really is more an elusive topic than really meets the eye. For our listeners I’ll hope you’ll visit us at and follows us on Twitter via our handle, which is @verosres for real estate solutions. Until next month’s podcast, thanks for listening.

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