Market Watch - The Surge is Working

A mathematical anomaly helps home prices recover.



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Home prices in the first four months of the year continued to surge at double-digit rates. A close look at these large gains reveals an important mechanism driving the housing recovery in the Coachella Valley.

Over the last 12 months, the median price per square foot of all normal sales (blue line) rose 7.5 percent. Normal sales are those by homeowners with home equity. The median price of the other type of sale — foreclosures and short sales — increased by 19 percent (red line). However, the median price of all sales (green line) — both normal and distressed sales — jumped 23 percent. A colored circle on each line represents the price one year ago.

This strange result — where the price of the total rises more than the price of either one of its two parts — is caused by a mathematical anomaly explained in the Distressed Market Housing Model, and it only occurs when distressed sales decline as a percent of total sales. This is exactly what has been happening: Over the same period, distressed sales declined from 39 percent to 18 percent of total sales.

Distressed Market Housing Model
Seldom does a theoretical construct like DMHM — created two years ago in an attempt to understand and forecast the desert housing market — work out as well as it has. We estimate that a little more than half of the 23 percent increase in the median price of all sales is from this special effect rather than from actual increases in the selling price of homes.

It’s the same mechanism that caused the huge price declines three years ago, when constant foreclosures entered the equation. Only this time, the mechanism is working in our favor. As the chart shows, foreclosure prices are always far below normal sale prices. That’s because a distress sale by a disinterested bank or homeowner always goes for less than the maximum value that homeowners seek when selling their own property. While the median price of all sales (the green curve) is always somewhere between the red and the blue, it falls closer to either the red or blue curve, depending on the number of distressed sales.

A Signal Indicating Complete Recovery
In the chart, You can see that the green line rises faster from year-ago prices because some of the upward move is due to the green line moving closer to the blue as distressed sales fall. These gains, while primarily mathematical, are nevertheless real and appear in home appraisal values. In fact, it is one of the primary mechanisms helping to vanquish short sales from the Coachella Valley housing market. Remember, a home is under water only on paper — when the appraisal value comes in less than the loan amount on the home. Any mechanism that produces higher appraisal values reduces the need for short sales.

When distressed home sales eventually become a negligible part of the total, the green and blue price lines will touch. This event, forecasted to occur near the end of this year, will be the final signal indicating a complete recovery of the housing market in the Coachella Valley.
 

Vic Cooper and Mike McDonald are partners in Market Watch LLC, a nationally recognized real estate advisory company that produces The Desert Housing Report. Visit www.marketwatchllc.com

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