The following has been reprinted with permission from the Oregon Appraiser Certification and Licensure Board — Spring 2008 Edition - Declining Market Designations and Market Forecast Analysis by Larry Green.
Part 1 of this two-part series began with an explaination of the the current situation by looking at how Fannie Mae, Freddie Mac, and guarantor mortgage insurance companies gather their data and identify “declining markets.”
In Part II of Declining Market Designations and Market Forecast Analysis Larry Green will discuss several tools that are available to analyze market trends. These include:
- The methodology to calculate the absorption rate
- Days on Market (DOM),
- List to Sale Price ratio (%SP:LP),
- Sale-Resale of the same property,
- Real Estate Owned (REO) activity
The issue of a declining market designation is closely tied to employing supply and demand analysis. Identifying and measuring the market is undoubtedly one of the most important procedures for all appraisers to have a clear understanding. The appraiser must know the composition of the market.
Some elements of comparison could be: the taxing district, school system, government services, park district, library district, location – urban, suburban, and rural, fire and police districts, lot/parcel sizes, utilities available, quality of improvements, and all identifiable physical attributes, such as age, condition, vehicle parking, and accessory amenities.
Let’s look at the supply and demand tool to calculate the absorption rate.
Here is the methodology to calculate the absorption rate:
- Identify and evaluate the subject’s attributes,
- Define the typical prospective purchaser profile,
- Assume the subject property is being presented to the market and design a sales search that will count the number of properties in competition with the subject.
- Count the number of:
- Listings available that compete with the subject’s parameters.
- The number of comparable sales that have closed in the past twelve months and divide by twelve (12) for the average sales rate per month.
- Note if there is an unusually high or low number of pending sale transactions because it could be an indication of a market change.
For example, based on your comparable sale search assume there are 75 sales in the prior twelve months, or 6 sales per month. You also searched available inventory using the same search parameters and found there are 145 competitive properties in current inventory. Dividing the 145 properties by 6, you conclude there is approximately 24 months of available inventory.
To identify and evaluate the subject’s attributes the criteria may include all or a combination of the following items:
- the geographic market area,
- listing and sale price range, and
- the subject’s basic physical characteristics.
The subject’s physical characteristics may include:
- the year built,
- number of stories,
- basement,
- number of bedrooms and baths,
- and garage spaces.
Recognize there is some crossover of buyer preferences between the number of bedrooms and baths so don’t be too specific. When you do this at least once a month and you have completed this process for several consecutive years, you will be able to know what is a high-buyer traffic and good sales year or a low-buyer traffic and not so good sales year. By the way, the number of properties sold from the available inventory is referred to as “the capture rate.” Clearly, supply and demand analysis to calculate market absorption is the easiest and best method to forecast market changes.
However, several other tools are available to analyze market trends. These include Days on Market (DOM), List to Sale Price ratio (%SP:LP), Sale-Resale of the same property, Real Estate Owned (REO) activity, and ratio of new construction to existing home sales. Since this article focuses on declining markets, we will omit discussion of new construction, but it is a useful analysis tool in stable and appreciating markets.
The DOM and %SP:LP tools are appropriate for use when a good reliable accounting of continuous and historic data is available typically from a multiple listing service (MLS) provider. The appraiser in a small market area can also apply this tool as long as they assemble the data regularly and have retrieval capabilities.
A sale search is commenced with the MLS system that might begin with the property type (i.e. single family residential, single family residential less than 5 acres, condo/ townhome, etc.) and the geographic market area for the number of new listings, average list price, pending sales, closed sales, average sale
price, median sale price, %SP:LP, annual DOM, and last 30 days on market. Some of these search parameters will not be available in all MLSs.
What is important here is looking at the relationships over time. Generally speaking, a %SP:LP today of 86% compared to a %SP/LP twelve months ago of 94% would indicate a declining market. When using this tool you should be aware price segmentation within the market can skew the %SP:LP. This happens when either there are an inordinate number of sale transactions that occur on either the upper or lower ends of the price range. Furthermore, some MLSs calculate the %SP:LP from the last adjusted list price and fail to consider the original list price, thereby calculating a higher ratio.
The same is true for analysis of the DOM. If average DOM today is 187 days and a year ago the average DOM was 145 days, a declining market is highly possible. The DOM tool can be adapted to measure the last 30 days compared to the same 30-day period a year ago for a snapshot of the market.
The DOM tool can also be problematic because some MLSs calculate from the last list price adjustment date and fail to recognize the property’s initial presentation to the market, or price changes between brokerages.
The analysis of a sale – resale transaction of the same property can be an extremely reliable evidence of a declining market, as well as, an appreciating market. This tool removes any differences in location, but adjustments are still likely needed for condition, improvements such as remodeling, and transactional differences, such as seller’s concessions. This tool is best applied within a spreadsheet grid where the original sale date, resale date are noted, and calculate the difference in years or months.
- First, the original sale is adjusted for property rights, financing concessions, condition of sale, and seller expenditures not included in the sale price required to facilitate the sale (such as a new roof, dry-rot repair, etc.) to arrive at an adjusted original sale price.
- Second, the same line items are applied to the resale price transaction to arrive at the adjusted sale price of the most recent transaction.
- Next, the difference in sale pricing is calculated less any seller’s recent improvements (these are improvements that would not be adjusted up for appreciation, such as expansion or remodeling), plus any deferred maintenance costs (these are items an owner needed to replace a component or perform some maintenance work but did not) to arrive at an adjusted difference. It is important to consider the contributory value of the improvement or remodeling rather than solely the cost of the project.
- Finally, the aggregate percent change and percent change per year is calculated. When this technique is applied to several sale – resale transactions it is a very convincing tool in support of negative and positive time adjustments.
Real estate owned (REO) is a very important consideration particularly in small market areas because it can drive the market. REO refers to properties owned by a financial institution. Typically, they are properties having completed foreclosure proceedings. For a financial institution, this can be a heavy burden because the Federal oversight banking system requires greater loan reserves for those institutions, which lessens their operating revenues. Consequently, these institutional sellers are motivated to sell the REO property quickly and many times at well below market prices.
To estimate the number of REO properties in a specific market area, the MLS search criteria might include searching the “marketing comments” or “agent comments” section for bank owned property. Online resources are an excellent portal for REO and foreclosures. Some searches can be completed by zip code.
The best method to search for these transactions is by public record ownership. When an owner transfers title to a law firm as trustee or lending institution, it is a good indicator the property is an REO.
In conclusion, the appraiser with these additional tools in their toolbox has the ability to look forward in examining market trends. The tools provide the appraiser with forward thinking ability to forecast changes in the market, perhaps before many others realize. It is this same forward thinking a smart investor uses to forecast future economic benefits from income growth and reversion.
As with any of the above supply and demand tools, it is not an exact science as is the development of your appraisal opinion. Appraisers tend too much to focus on history and forget about forward thinking. In declining markets as well as highly appreciating markets, the appraiser should look both ways.
- Download declining_market_designations_and_market_forcast_analysis.pdf
- http://oregonaclb.org/media/Spring2008Newsletter.pdf
- Inman News: Where's the beef in Case-Shiller Attacks?
Author: Larry R. Green, Appraiser Compliance Analyst, Oregon Appraiser Certification and Licensure Board, 3000 Market Street NE, Ste. 541, Salem, Oregon, 97301. Tel. 503.485.2555 eMail: [email protected] -
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