More Housing MisInformation... When Will it Stop?

Poor REALTORS! The misinformation campaign about the housing market continues with yet another announcement of a “drop” that is entirely meaningless. When will real estate brokers take control of the information story?

<!--more-->Yet another announcement is making the media rounds today, lowering confidence and confusing the consumer. Trulia (amongst others) released data today indicating that home sellers “slashed” prices for homes "on the market" last month. The media, untrained in either economics or real estate, is churning this report as if the “market has dropped” once again. Even financial networks are making the mistake of saying this latest price reduction continues to “wipe out” billions of homeowner equity.

Really?

Let’s pretend you go into your backyard and, using materials acquired with your credit card, build a dozen birdhouses. You then place those birdhouses on a table in the town square, and set a price for them. After a month, a few people have stopped by but nobody has purchased. So you reduce the price of three birdhouses by 30%. Suddenly, consumers purchase those three birdhouses, while the other seven remain unpurchased.

Does this mean all of birdhouses - including the overpriced ones - were "on the market" last month? Of course not.

The error in this story – and the current housing reports – is that the entire supply of inventory was “on the market” in the first place. In fact, it was not. Homes that are overpriced are not “on the market.” Homes with signs in front of them are not “on the market.” Overpriced supply represented by advertisers and entered into a MLS database or website are not “on the market.”

Nothing is “on the market” unless and until a buyer shows up and purchases it.

Basic economic theory requires both supply and demand. Markets don’t come into being both parties come together, until a buyer purchases (or at least makes an offer to purchase) something from a given supply. The mere collection, pricing and marketing of products – houses, computers, cars, whatever – only constitutes supply. Unless buyers show up – with demand – and actually purchase, it’s a mistake to call the supply and advertising a market.

This might seem like a fine point, but it’s a critical one. Most MLS and real estate portal sites are not markets. They are databases. Portions of their data represents the market. But it’s not the supply prices.

Only offered prices represent the level of the market. That's because offers only occur at the equilibrium point between sellers and buyers. And that's where the market occurs.

Reporting seller pricing – and its ups and downs – is an exercise in misunderstanding markets. It’s closely tied to the erroneous tracking of another market statistic: days on market. Most MLS and portals calculate days on market as the time since the property was listed by a REALTOR to the current date. But if nobody has been making any offers, can we really say the home has been on the market for those days?

Not a chance.

Markets operate on the principle of price equilibrium. Prices require demand and supply. Reporting only on the prices of supply tells only half the story. Housing oversupply might be depressing prices – but only of sold homes - not unsold ones. Price adjustments on unsold homes are a normal market mechanism, because sellers have imperfect information and their emotions often override more reasoned price considerations. It happens in every market, boom or bust. A drop in seller price guesstimates only indicates their proper correction of pricing judgment. What's more: falling prices for houses "for sale" but purchased with little or no money down doesn't mean a loss of anything on the seller's part. In many cases, certainly not equity.

A real drop in the market can be measured by comparing prices that induced offers this month to prices that induced offers last month. That’s where the “market” levels exist.

Why does this point matter? Three reasons: First, misinterpretation of price reductions as a drop of homes in the market harms consumer confidence. It conflates demand with price. Actual buyer demand may not have changed at all (the price of sold homes may be holding steady in the same markets, which it is in many places). Second, equating price reductions with a loss of market value – Trulia says nearly $34.8 million was “slashed” as if it was lost – is another fiction. If an $100 overpriced birdhouse gets no offers, but $50 ones sell quickly, did the seller really lose $50? Not necessarily, especially if the house was initially acquired with no real cash. Even short-sales don’t cause sellers a “loss” because in most states, there is no recourse: sellers don’t pay the lost different or get taxed on the forgiven (short) principle.

Yet it’s the third reason that this market misinformation is particularly harmful to the housing industry, regardless of boom or bust. Misrepresenting seller price reductions as a loss of market value validates the practice of overpricing by sellers. It makes it seem like initial seller prices were somehow “market” prices, and that it’s only some “dysfunction” of the market that is causing them to lower their asking price – and lose value. Economists – and real estate professionals – know this is a fallacy. It is an error of pricing in booms, and it’s equally an error of pricing in recessions. If the real estate industry is ever going to clear current supply, and pursue better practices in market creation in the future, it’s time to stop reporting fictional measurements as actual market changes.