Tuesday, September 12, 2006

Housing Heating Up Overseas + Flawed Index

A story in the recent Economist about Housing Prices just reinforces what we already know. The US housing market is 'cooling'. They don't want to come right out and say it's crashing, but considering the index that they use, they don't really have to.

You see, the "OFHEO index is thought to be more reliable because it tracks price changes in successive sales of the same houses." And that sounds very nice and good. But there is a fundamental flaw in an index of that sort.

Unlike a stock market, where there is massive liquidity, you can't just unload a house and sell it. Houses are not as liquid as stocks. Wasn't that the great selling point that realtors used over and over during the boom? Well, it's a double edged sword.

When housing markets collapse, the values of the homes don't immediately start dropping. Instead, the entire market chokes up and grinds to a halt.

A disconnect forms between the sellers of the houses and the buyers. The buyers, faced with numerous options, float lowball offers knowing that the seller is behind the eight ball. They have no sense of urgency. They know they can wait the sellers out.

The sellers, on the other hand, refuse the offers, trying desperately to hang on to the paper profits they have already counted in their minds. They don't want to admit that they mistimed the market. So, they decide to sit on their property and wait. It's the old buy and hold strategy. Unfortunately, the only thing they are holding is the bag.

The Mexican Standoff is now in full swing. Both sides think they can wait the other side out. Housing sales stop happening. Inventory piles up. All of a sudden, your comps are not from houses that have sold a few weeks ago, they are from houses that sold last year. It starts to get hard to establish the value of a house.

Nothing happens.

Open houses are exactly that... open houses. Empty. The prospects are nowhere to be seen. Time passes. Now, the weaker parts of the boom herd start to go down. The people with ARMs and the like. Or the flippers, who swam in with the tide and got trapped on the beach.

They can't afford to wait things out. They see their losses mounting with each passing day. They will be the first to cut and run. And that's when the bleeding will start. But, the OFHEO index won't show any of that.

You see the problem, right? The index is based on consecutive home sales. But what happens if nothing is selling? The index goes blind. It goes blind until the panic sets in, and the prices get low enough to coax the buyers off the sidelines. It's a great indicator during a fast paced market. But it sucks when things slow down or stop.

Still, there seems to be good news. The real estate game seems to be in full effect in many European countries. So, if you can't bring yourself to stop playing with fire at home, maybe it's time to take your chances abroad. After all, having lived through this market, you should be an expert by now. Best luck, and much success!