Realities of Real Estate: The herding effect in home sales

As a well polished Realtor, you’d never suspect that Donna used to be a cowgirl.

Along with her five sisters and one brother they worked a cattle ranch in southern Idaho. I don’t know how many acres the ranch is. A while back, I learned that asking a rancher how many acres he has is considered impolite and somewhat like asking a city slicker how much money he has in the bank.

But the family ranch is fairly large and has enough cows to keep everyone busy. In the wide open spaces of the west, it’s amazing how a handful of cowboys (or cowgirls in the case of Donna and her sisters) could effectively control hundreds, sometimes thousands, of cattle and manage to move them from point A to point B. This ability has always confounded me, especially when I see how a mom and dad at the mall can have trouble keeping just three kids in line.

Well, what makes driving cattle possible is “the herding effect.” I found on the Internet (you can find anything on the Internet) that a trail boss would want to have about one cowboy for every 250 head of cattle. Get some real experience riders, and you might make do with one buckaroo for every 400 head. In short, a few key individuals can have a great impact on leading a much larger entity.

From cows to Cape Cods, there’s also a herding effect in home sales.

People always find safety in numbers, and when homebuyers sense a change in direction, the psychological shift in attitude can have a rapid and drastic impact on home sales. Events can shape market trends, but similar to a cattle drive, a relatively small group of respected opinion makers can also have a considerable influence on overall market sentiment.

When it comes to the housing, one of the most highly respected methods for evaluating price trends is the Case-Shiller Home Price Index. Standard and Poors describes the index as follows: “The Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family homes re-sales, capturing re-sold sale prices to form sale pairs. The index family consists of 20 regional indices and two composite indices as aggregates of the regions.”

Roller coaster ride

If you look at a graph of the Case-Shiller 20 market composite, it’s possible to clearly see the inflation, and subsequent deflation, in housing prices. Following this roller coaster ride, the index has remained essentially flat since mid-2009. In fact, this index was at 141.97 in June 2009, and the latest release in September 2011 has the index in exactly the same spot.

During that same period, the Las Vegas market has continued to show further price deterioration, with the index dropping 13 percent. Conversely, Washington, D.C., is bucking the trend, establishing itself as one of the few bright spots nationwide for housing prices. From June 2009 to September 2011, prices in the D.C. market are up 9 percent.

We make note of this, because the Case-Shiller index is so highly regarded that it can set off the herding effect and help generate a change in market direction. For local housing markets that benefit from the halo effect of Washington, D.C., places like Anne Arundel County, home prices have clearly turned the corner and are back on the mend.

The Case-Shiller index is imperfect and is sometimes criticized, because it only looks at major metropolitan areas. But, we consider it a pretty good barometer of market prices.

Despite the encouraging data, Robert Shiller is a careful, scholarly guy. He has a Ph.D. in economics from MIT, so he’s not prone to compulsive responses when there’s improvement with the data. Shiller wrote a book titled “Irrational Exuberance,” a term first coined by Federal Reserve Chairman Allen Greenspan in his description of the overheated “dot com” economy in the mid to late 1990s. There was even a second edition to the book.

As a result, Shiller isn’t one to ring the all clear unless the numbers clearly make the case. Although Washington has been trending up for a couple of years, continued weakness in the overall economy is still reason for caution.

Nevertheless, if housing prices show some lasting evidence of recovery, lenders may begin to relax loan qualification requirements, along with the need for a large down payment. This, coupled with an improving stock market, stabilization in the European Union and a further reduction in housing inventories could help restore sustainable growth for home prices. And due the herding effect, if people start to sense that they’re missing the bottom, they may begin to rush in, hoping to get on board, before this train leaves the station.

However, the recent recession has burned people in a way not seen since the great depression, and problems with the economies here at home, as well as abroad are far from fully resolved. Consequently, we expect a good deal of restraint, especially when it comes to big purchases, like a house. With cash for clunkers, people are willing to put their toe in the water on a new Toyota Corolla. But, laying out four or five hundred grand on a new house is more like diving in head first.

We’ll keep an eye on future changes in the Case-Shiller index, and let you know where the numbers appear to be pointing.

Importantly, this index is not normally susceptible to head fakes or unwarranted changes in direction. The increases recorded for the Washington region are a good sign and point to a recovery that will be ahead of the nation as a whole. Unless the federal government actually starts to significantly reduce its workforce (an improbable scenario), it is unlikely that housing price trends for the Washington market will reverse direction.

Places like Las Vegas still have a lot of ground to recover, but at least for our local market, we can hope that what happens in Vegas stays in Vegas.

Bob and Donna McWilliams are practicing real estate agents in Maryland with more than 25 years of combined experience. Their email address is [email protected].