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Sunday, January 16, 2011

Housing stats can be deceiving

Tony Paradiso

I promised to make more predictions this week, but my attention span leans toward the microscopic. Instead, I want to discuss a Wall Street Journal article that illustrates how deceptive statistics can be, while also striking a hopeful tone regarding the number of homes that are underwater.

“Underwater,” or negative equity, refers to homes where the amount owed exceeds the home’s value. Owners experiencing negative equity have three choices: sell the home at a loss, walk away from the mortgage, or stay put. The walking away option is most problematic as it adds to the foreclosure ranks and depresses real estate prices.

I’ve addressed the problem numerous times because purging foreclosures is essential to a housing turnaround. Prices simply won’t turn until the majority of foreclosures are settled. By the way, that probably won’t happen until 2013. There: one prediction, to keep my commitment.

It’s been widely reported that as many as one in four homes is underwater. Moody’s pegs the problem at 30 percent. Both numbers make headlines but neither represents reality. I’ve been personally suspect of the estimates because if they were accurate we would be in the midst of real estate Armageddon, and the market isn’t world-annihilation bad.

Sure enough, the Journal article explained how the statistical methodology inflates the number. The following quote sums up why it’s important to do your homework before you believe what you read – except for the stuff in this column. That you can believe.

“Everyone likes to get headlines, so they tend to overstate problems like this, without doing ground-level research,” says Kenneth Rosen, chairman of the University of California, Berkeley, Fisher Center for Real Estate and Urban Economics.

What do you know, the exception to the rule: an economist with half a brain.

Kenneth’s comment is on the money. Sadly, that’s how the media works. Be sensational or get lost in the noise. The truth be damned. And economic data is not immune. Remember the idiots that predicted Dow 36,000? Actually, I can’t remember their names but I remember their “call” being widely covered.

Correctly estimating the level of negative equity requires one to correctly calculate two things: the level of debt and the value of a home. Sounds simple except that the two companies that produce the most closely watched estimates – CoreLogic and – both deal with flawed or incomplete data.

For one thing, the companies only examine homes that are mortgaged. But guess what, according to the U.S. Census Bureau, as of 2009, one-third of all owner-occupied homes have no mortgage. So last month when CoreLogic reported that 22.5 percent of mortgaged homes had negative equity the reality was that only 15 percent of all homes were underwater.

Then there’s the issue of how a home’s value is estimated. The typical method is to look at comparable properties that have sold. To improve the accuracy of these estimates, research firms regularly test the values to ensure that there is no directional bias. In other words, the estimates may be wrong but they would be wrong the same amount in both directions. That seems reasonable, except when it comes to estimating negative equity.

CoreLogic says its estimate is within 10 percent of a sales price for 55 to 75 percent of the homes. Zillow’s estimate is within 10 percent for 50 percent of the homes. According to the Journal, these margins of error tend to inflate the number of underwater homes “for a subtle statistical reason.” That’s because there are many more homes that are slightly above water than slightly below. Ipso facto: flawed valuations cause a greater chance that a home is incorrectly pushed into the negative category than the other way around.

Additionally, the headline number doesn’t take into consideration that homes with small amounts of negative equity are not problematic because no one is going to risk screwing up their credit if they’re floating around breakeven. In most cases where the amount is small, owners don’t even know which category they’re in. In fact, CoreLogic estimates that a 25 percent level of negative equity is necessary to pose a significant problem.

So what’s the reality?

For mortgaged homes, 49 out of 100 homeowners owe less than 75 percent of the value of their homes. Twenty-four out of 100 owe between 75 and 95 percent. Excellent: 73 percent of mortgaged homeowners are in good shape. An additional 4 out of 100 owe 100 to 105 percent. Statistically and practically, this group poses no problem.

Basically, there are three problem groups. These include those who owe between 105 and 110 percent, 110 to 125 percent, and more than 125 percent of their home’s value. In total, these groups account for only 19 percent of all homeowners. This is already lower than the advertised negative equity number.

However, now we must adjust for the margin of error. Conservatively, we can assume that approximately half of those who owe less than 125 percent of their home’s value actually belong in the “no problem” group. Applying this final adjustment yields a number that more closely represents the actual magnitude of the problem. And that number is in the neighborhood of 10 percent of all homeowners.

Not great, but certainly more encouraging than what the experts would have us believe.

Author, professor, entrepreneur, radio and TV commentator, Tony Paradiso is a marketing and management expert and CEO of Phoenix Finishings.