Friday, October 4, 2019

How to Analyze and Utilize Case-Shiller Price-Tiered Indices – The Boston Case Study

As indicated in prior posts, not all price segments of the same housing market necessarily move in tandem. In a well-distributed and liquid market, the price escalation generally starts at the low price tier and graduates up with the strengthening of the underlying market fundamentals.

The above table demonstrates that while the Low tier (under $395,499) registered an excellent overall growth (between January 2017 and July 2019) of 17.90%, the two upper tiers returned much lower growth rates of 13.35% and 10.59%, respectively, thereby staying significantly above the aggregate growth rate of 12.55%. Similarly, while the Middle tier did not perform as good as the Low tier, it did return a better growth rate than the High tier, remaining above the aggregate growth rate as well. The segment-wise growth rates prove that one-size-fits-all growth rate does significant injustice to both ends of the price curve.

So what are the primary uses of the Case-Shiller price tier analysis? 

   1.   To Time-adjust Prior Year Tax Roll Values – When analysts and appeals consultants do not have the time or resources to develop new market values to challenge (validate) the current Tax Roll (market) values, the Case-Shiller tiered growth factors could be an ideal independent alternative. Given its independence, it would be much easier sell than some internally developed heuristic rates. Of course, the counter case could be compelling too: Since the Case-Shiller markets are defined at the MSA level, the County Assessor could make  a case that such time factors are too broad-based to be meaningful at the County (small subset) level.

   2.   To Challenge Internal AVM Time Adjustments – AVM modelers can use the tiered time factors to challenge the internal AVM time factors. The Case-Shiller factors should be in line with the large subsets; for instance, LA County time factors should be very similar to those of Case-Shiller’s. Therefore, the internal QC supervisors, both private and public, should additionally use these independent factors to test the metallurgy of the internal models. Needless to say, those who develop models at the MSA level would be the big beneficiaries of the Case-Shiller tiered time factors.     

    3.   To Periodically Update Mortgage Portfolios – Mortgage portfolio analysts can use these factors to periodically update the portfolio values, without having to develop challenger AVMs. These factors are more meaningful when the mortgage portfolios are rolled up at the MSA or regional level. Conversely, one must be careful in over-using these factors at the small subset level, unless prior studies show that those subset factors tend to align well with the MSA’s.

   4.   To Update a Not-so-recent Comparable Sales Pool – When an analyst or a loan officer must work out of a not-so-recent comparable sales pool, these Case-Shiller factors could be used to time-adjust at least the older sales. Of course, it would be a quick fix, but not a real valuation solution per se. This method is especially helpful in some bigger environments (e.g., AMCs) where the time-adjusted comps are often used in batch modes, in place of the 3rd party AVM values. 

    5.   To Enhance Shelf-life of AVM Values (sell side) – AVM houses sell their values to wide range of end-users like banks, mortgage companies, assessment jurisdictions, SFR rentals, REITs, large tax appeal lawyers and consultants, hedge funds, etc. Many such AVM houses outsource the development of the modeling and value generation to 3rd party research outfits, professors, etc. Case-Shiller tier indices help them to apply time adjustments and thus enhance the shelf-life of those AVM values, easily up to a year.  
    6.   To Enhance Life Expectancy of AVM Values (buy side) – Even the 3rd party non-custom AVM values could be quite expensive, e.g., $5 to $10 per parcel. Given that, many end-users can use the Case-Shiller tier indices to enhance the usefulness of the AVM values for several quarters, thus saving a ton of money. In fact, those internally time-adjusted AVM values, oftentimes, are very similar to the new values that the originating AVM houses sell. Anecdotally, some tax appeal consultants use smart college students to have their old AVM values adjusted up to the new target date, meaning the new Tax Roll (valuation/status) date. 

   7.  To Develop Analysis for Investors – When researchers are required to develop inter-market (across markets) comparisons for investors, the Case-Shiller Price Tiered indices are more useful than the un-tiered composites as these indices allow true apples-to-apples analysis. Therefore, in order to compare two competing markets, one should compare by the tiers rather than the overall markets, allowing investors to understand the current valuations of each market segment; for instance, when the Low tier makes a significant upward run, investors might shy away from that market segment (and perhaps vice versa). So, the one-size-fits-all market analysis does not work well for the investors. 

    8.   Flight to Quality in Financial Markets – The three tiered index helps smart investors and traders to swap investments back and forth between the housing market and the equity market as the latter comprises primarily of three price segments as well, i.e., small cap, mid cap and large cap segments. While rotating investments, the smart investors and traders who would naturally prefer studying the competing markets by price tiers, to avoid having to rotate from one over-valued market segment to another similarly over-valued market segment (thus defeating the basic purpose).    

(Click on the image to enlarge)
    9.    To Understand True Volatility – When the volatility is important to the organization, developing the tiered price volatility is critical as it does not mask the two ends of the price curve. The above volatility table shows that the Low tier has been lot more volatile than the upper price tiers. The reason is simple: the high growth (expanded price range) segment comes with higher volatility while the low growth (more compact price range) paves the way for lower volatility. Case in point: If the aggregate rate of 3.71% is used across a portfolio, the volatility of the low price tier of the portfolio would be understated while the high price tier would be overstated, thus distorting the both price segments. Of course, the middle tier would be in line with the aggregate rate. 

 When the new values are not immediately available, the Case-Shiller tiered price indices come in very handy while updating the older portfolios, rotating investments across financial markets, and understanding the true underlying volatility of the housing market. 

 P.S. These are Case-Shiller’s seasonally-adjusted indices so the month-over-month comparison is fine. While using Case-Shiller’s seasonally unadjusted indices, one should compare July 2019 with July 2018 and July 2017, etc.

Sid Som, MBA, MIM
President, Homequant, Inc.

Link to the Book
How Case Shiller Indices Have Taken Over Housing Data Analytics (and How You can Benefit from them) 

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