Inside and Outside the Boxes:  Cycles, Trends, and Perspectives

In part one we addressed "Definition of the problem", ... What does FNMA want to know? In part two we'll look at cycles, trends and perspectives.

"Short cycling": Pedaling the real estate cycle
Appraisers are taught about the life cycles of a neighborhood; "growth, stability, decline and recovery". This is the physical cycle of the neighborhood, not the real estate cycle. The real estate cycle is influenced by interest rates and the local economy, has an irregular pattern and generally lasts 3 to 6 years.

Unlike real estate or neighborhoods, housing demand doesn't "cycle", instead, it "contracts and expands" to meet the needs of the market. To understand housing, we need to examine the "collective market" (all housing types, single family, apartments, etc.), the economic, social, governmental and environmental forces acting upon it and also the "segmented market" for the specific property type (single family condo, land, etc.).

When supply and demand are out of balance, participants in the market often act in a manner that does not reflect the direction of the collective market. Price is what someone is willing to pay, while market value reflects a price that is justified and sustainable within the market, the collective judgment of the market and not the actions of speculative or uninformed buyers.

At the peak of the market and prior to, many homes were purchased at prices that were "not justified", driven by speculators or uninformed buyers. Even though prices (and in theory values) have receded from the peak, perspective on the rise in values and price points over time is necessary for the client to identify and measure the risk associated with the property.

Simple in theory ... more complex in practice
In many markets, "housing problems" are not a result of "a lack of demand" but rather a shift in demand from "purchase" to short-term rental. This is the "market's correction" in response to over-pricing. The housing market isn't "over-supplied", as much as it is over-priced.

The national economy is expanding, despite problems in housing. Population is increasing, as is employment. With an expanding economy, gains in employment and a growing population, there cannot be a "decline in housing demand; there can only be a shift in housing preference". While the "for sale" market may be experiencing difficulty, other segments such as rentals are faring better. Even in a declining market you can have neighborhoods or segmented price ranges that are outperforming the collective market.

FNMA and the 07-11 announcement... Where's the beef?
FNMA 07-11 requires the appraiser and lender to determine and report the trends. "Increasing," "stable" or "declining" aren't defined, raising the questions, "What determines the trend and how is it measured?" Is it a change in price over a short time period (3, 6 or 12 months) or the movement over the short real estate cycle? What signals a shift from decline to stable or increasing and how do appraisers support a change from one trend to the other?

It's acceptable to select either the increasing, stable or declining box when data clearly supports such a trend, however in a fluctuating market it is critical for the appraiser to present perspective of the trend over a reasonable time period (short real estate cycle - 3 to 6 years) and to qualify the nature of the trend as primary or secondary.

Primary trends are longer-term, lasting years while short-term (secondary) trends can be caused by any sudden imbalance in the market (supply, demand, etc.). The primary trend may be showing a price increase over a 5 to 10 year period, while the short-term trend reflects a market correction (decline) due to excessive pricing, over-supply, etc.

How can this be analyzed and communicated to the client?
Graphing the SREC will provide the reader with a visual of historical price points, market peak and correction that reflects the overall price pattern of the market. For example, the trend analysis over 2000-2007 is shown for new and resale housing in the Las Vegas, NV market.

  • The primary trend for both new and resale housing is increasing over 7 years.
  • The market correction is apparent in the graph, showing both the 3 to 6 year trend (short real estate cycle) and the more recent correction.
  • While current prices (secondary trend) are below the market peak, they are still above 2000 - 2004 price-points.

Las vegas home prices 2000-2007

Presenting both trends provides the client with perspective of the overall market. The client can see that homes acquired prior to 2004 have price points below the current decline and that purchases after 2004 have greater risk if the decline continues.

Both primary and secondary trends are important to gain perspective of the overall housing market, however the URAR is asking for neighborhood trends. While FNMA cited several trend information sources (Case-Shiller, NAR and OFHRO), it's important to note that these are trends of the overall housing market in major metropolitan areas and do not reflect a specific neighborhood or segmented property type or price range.