Releases such as the Case-Shiller home price index and the CoreLogic Home Price Index, which both report data on average sales prices for residential properties, provide some insights into the strength and direction of the housing market. But there's something unique about the nature of the current housing market that could cause the headline numbers reported by the major house price indexes to be distinctly misleading.
The residential housing market is at present a distinctly two-tiered market-- the two tiers being the distressed market (REO sales, short sales, etc.) and the non-distressed market (voluntary sales by private property owners). The average sales price for distressed sales is a steep discount to the average sales price for non-distressed sales... in some markets, the average discount is or has been 50% or more at times!
While the major home price indexes often break down the numbers into both distressed sales and non-distressed sales, the headline numbers they report are based on averages across all sales. In a two tiered market, this creates a possibility that the house price index can decline, seemingly showing weakness in the housing market, even when average prices in both the distressed and non-distressed markets are increasing.
Let me demonstrate with a hypothetical example. Suppose in May we had the following data:
100,000 non-distressed sales at an average sales price of $250,000
100,000 distressed sales at an average sales price of $150,000
Crunching the numbers, 200,000 total homes would have sold in May for a total of $40 billion dollars. The average sales price for May would be $200,000.
Then, suppose that in June, average house prices for both distressed and non-distressed properties rose 2%. And since the non-distressed market was strengthening, banks decided to release and sell significantly more of their foreclosure inventory. We have the following data for June:
100,000 non-distressed sales at $255,000 (up 2% from May)
130,000 distressed sales at an average sales price of $153,000 (up 2% from May)
230,000 total homes would have sold in June for a total of $45.39 billion dollars. The average sales price for June would be $197,348. That's would be down over 1% from May. In other words, in this scenario the headline numbers reported by the house price indexes would show that home prices had fallen in June despite the fact that the average sales price in all areas of the market had increased in June.
This seeming paradox can happen because the overall home price indexes represent the average selling price of apples and oranges, and the mix of what is sold can change. When the ratio of distressed to non-distressed sales changes, month to month comparisons of overall average selling prices are quite literally a comparison of apples to oranges.
This seemingly far-fetched scenario is not far-fetched at all; in fact is it likely to occur. Banks have significant discretion over when they release their inventory to market and are likely to quickly take advantage of any strength in the market to sell more of their property.
By the way, just the reverse of this hypothetical scenario can happen-- the housing market can weaken, causing banks to sell less of their foreclosure inventory, shifting the overall mix away from lower priced distressed sales, which will tend to boost overall average sales prices even when both distressed and non-distressed markets are weakening.
So, if you follow the trends and read the reports the monthly house price indexes, be sure to pay close attention the movement in average sales prices of distressed properties and non-distressed properties, rather than just the overall average.