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The Market Price is the Last Price

By Charles Sizemore⋅ November 5, 2009 ⋅ ⋅ Post a comment

A friend of mine looking to sell his home in suburban Fort Worth got a rude awakening. The estimated market value of his home dropped $20,000 almost overnight. When he asked the realtor what happened, he found out that the last comparable sale in the neighborhood was a foreclosure. And even though that foreclosure price was not a “normal” market price, by virtue of being the last sale in the neighborhood, it became the new market price, dragging every other home in the neighborhood down.

The greatest benefit of a liquid market is it role in allowing “price discovery.” The interactions of buyers and sellers send the signal of what an object is worth via the clearing price. But the key here is “liquid.” When sales are infrequent, prices become stale and no longer reflect reality.

In the housing market, this can be seen in a couple different ways. If demand is in freefall and it’s been a while since there was a sale, the “market” price will grossly overstate the “real” price. But likewise, if demand is relatively strong but the last sale was an aberration (such as a low-ball foreclosure sale), the market price can understate the real price. In either event, it can make the sale of a house complex and downright tricky to negotiate for both buyer and seller.

The NY Times ran a good story this morning about this topic: “Getting Real About Home Prices”

The Times writes,

Even in the best of times, it’s hard for individuals to objectively value their homes, which often reflect their sense of self and personal style. Making things even more difficult has been general market inactivity lately, if not paralysis, which has provided little in the way of pricing guidance. But by using online resources, investigating neighborhood trends, consulting real estate experts and perhaps even asking the opinions of brutally honest friends, homeowners can arrive at a reasonably accurate appraisal even in these uncertain times.

Of course, as the Times tells us, in the end “the value of a home is the price the buyer is willing to pay.” And in most areas, it is still very much a “buyers market” in the sense that sellers have very little negotiating power. This is not something we see changing any time soon.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

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Discussion

3 comments for “The Market Price is the Last Price”

“the value of a home is the price the buyer is willing to pay.”

Actually, in the Chicago market, we are seeing the bank dispute the appraisal, even when it supports the value agreed to by the willing buyer. The bank says the appraisal is too high, requires another, and then forces the seller to lower the price …. which had been previously agreed to by the buyer. After this process was repeated two more times by the lender, my client (the seller) just yanked his house off the market. Using these dropping appraisals, the lenders have forced him to drop him home price with three separate appaisals. By the fourth one, he had had enough.
PS. Now, the bad news. He may never be able to sell his home in the future if he does not accept these lower prices.

Posted by lawbiz1@comcast.net | November 5, 2009, 12:36 pm
I ran into this exact situation a month ago.
Went to Bank of America (mistake #1) to refi.
They took my $400 bucks and sent someone out with a camera to do the appraisal. I received a nice big packet of the appraisal in the mail, bottom line denied.
Why?
Because even though the replacement cost was $185K the market value based on distressed sales in the neighborhood was only $100K.
To which I replied, perhaps I should disassemble the house and sell off the pieces.
With a new wave of mortgage resets coming in 2011 & 2011, I’d say America is in big trouble.

Posted by lkurowic | November 6, 2009, 9:07 am
The statement that “the value of a home is the price the buyer is willing to pay” misses a crucial point. The value is what a buyer is READY, willing AND ABLE to pay. In the example given in which the comparative value for a home dropped by $20,000 due to a foreclosure sale, the ramification is in fact dire and perpetuates the decline in prices. This is because the potential buyers of other homes will likely be subject to a lower appraised value by potential mortgage companies which will almost certainly use the lower ‘comp’ in their calculations. This in turn limits the mortgage amount for other pertinent surrounding properties. So, even if a potential buyer of a nearby property is willing to rationalize the lower comparative price as an aberration, mortgage companies will not go along with it. This isn’t speculation….talk with a realtor in any distressed market. This means that the possibility for a $20,000 higher price, will likely result in a sizeable additional cash requirement by the potential buyers. I.e., in the case of an 80% mortgage, the buyer would be required to put down 20% of the lower appraised value, plus the $20,000 they are “willing” to pay over the appraised value. Let’s face it, at a minimum that eliminates all potential buyers with limited cash, from paying the higher “rationalized” price. This situation describes a very potent element in the continued downward spiral of home prices to add to all the others.

Posted by azenman2@yahoo.com | November 7, 2009, 12:53 pm