Thank you Vincent for sharing this interesting article on predicting future home values. http://www.analyticbridge.com/profiles/blogs/here-s-what-your-home-will-be-worth-in-12-months?goback=.gde_4520336_member_226716431
I’d like to tell a story, though, that may help predictive modelers take extra caution.
If anyone understands the “real” state of the housing market, this is one market where predictive models can fail miserably, and Zillow is not immune. Predictive models and forecasting can work well in normal market conditions and can be indicative in “almost normal” markets where major influencing factors can be well understood, as well as when the forecast period is relatively short.
But trying to use predictive models in abnormal markets, when core assumptions on predictive elements may be inaccurate, when new, complex relationship factors are not well understood, when one-time disruptive events cannot be assessed…well, that’s where things can break down in a hurry. Bottom line: make sure your model is sound, considers the right variables, and is tested and retested over time before you rely on its results.
The Zillow Home Value Index is the median value of a home for an area. The Zillow Home Value Forecast is Zillow’s prediction of what the Zillow Home Value Index will be one year from now. Zillow uses data on a number of housing indicators as well as general economic indicators. The housing indicators include the mortgage interest rate, property tax rate, construction costs, number of vacant homes, percentage of loans that are subprime, percentage of delinquent loans and supply of homes for sale. The general economic indicators include the change in household income, population growth and unemployment rate.
Underlying factors that make this real estate market anything but “normal”:
The FED‘s easy money policies of the past (which affect the financial markets across the board) created excess money that found its way into the hype of the dot-com’s. When the truth was exposed, the dot-com bubble burst. Over time, continued easy money policies kept excess money in play, which found its way into real estate. Lenders saw a once-in-a-lifetime opportunity, threw risk to the wind and created sub-prime mortgages for the ‘high risk of default’ market.
The gov’t also saw an opportunity for political pursuits (and yes, for economic growth), and they created massive programs that encouraged home ownership for lower income households. These two factors had a multiplicity affect, raising the % of home ownership from ~65% to ~69% in a relatively very short order. The feeding frenzy caused a very abnormal increase in prices, and countless homeowners tapped into their equity to finance their high consumption lifestyles.
Lenders saw an even greater opportunity to package up loans, securitize them (turn them into stocks, essentially), and sold big bundles of them to unsuspecting investors, oh ya, with regulatory agency encouragement. Now, lenders freed up their capital reserves to do more loans, and they had sold their risk (especially sub-prime risk) to others. Happy times for lenders, happy times for the gov’t, and happy times for homeowners…until the real estate bubble burst.
Real estate prices fell rapidly. Real people lost their jobs, tightened their belts and curbed consumer spending, affecting the entire economy. Delinquencies increased (go figure!), foreclosures increased (go figure!), unemployment climbed (go figure!). Lenders tightened lending standards too much. The gov’t bailed out many who had their hands in the cookie jars. But the FED kept on truckin with easy money, abnormally low interest rates, economic easing and bond buy-backs to try to stimulate a crippled economy. (Now, the bubble is gov’t debt, but that’s another story.)
So, today’s real estate market: First, lenders are not processing delinquencies and foreclosures in the way they should, because they don’t want to show any more homes on their books. Many families (more than you can believe) have lived scott-free for 12-18-24 months or more – not paying their mortgage, knowing that their lender is not pressing forward with their foreclosure. Second, lenders are slow to process short sales (lender allows the homeowner to sell for less than the outstanding principal, so the lender does not get fully paid out at closing). Third, lenders (and the gov’t – HUD, etc.) already have a huge inventory of REO properties (called the shadow inventory), and they certainly don’t want any more.
But here’s the rub…they are not processing these properties and not putting them back into the market as they should… and THIS is causing an inventory shortage in some areas (e.g. So Calif), causing prices to climb back up. Think of the affect this has on a predictive model – what would happen to home prices if the lenders and gov’t dumped their shadow inventory? Some say the banks want prices to go back up before they dump their inventory. I think bigger, hidden motives are underlying this move. The media and politicians have jumped all over this, claiming that the real estate market is in full recovery.
Looks good for the real estate market. Looks good for the economy. Looks good for lenders, the FED and the gov’t. “Things have improved. The housing market is firmly on its road to recovery. The housing market is strong. etc.”
But it’s all artificially created, resulting in a highly abnormal market with extreme uncertainties – the FED’s ultra-low interest rates, the FED’s easing policies and bond buy-backs, still strict lending standards, lender’s immediate resale of a mortgage to free up more capital for more loans (retaining absolutely zero risk), CDO rating agency conflicts of interest, huge shadow inventory kept out of the market. Also, huge hedge funds (example here) are now getting into real estate and buying up thousands of residential properties, for cash, completely disrupting local markets and typical real estate investor business models (who, by the way, offer a tremendous stabilizing value to the real estate market as a whole, but are much maligned by the media, lenders and the gov’t). What affect do these hedge funds have in the predictive model?
And oh, let’s not forget about the real unemployment rate (see www.bls.gov and http://www.bls.gov/data/#unemployment …the gov’t and media should report the U6 number, not U2…PLEASE, go to bls.gov and read about the real U6 unemployment situation…don’t rely on the media), the current trends on personal income and consumption, total consumer debt obligations, changes in payroll taxes and other taxes schedules and loopholes, the affect of Obamacare on household incomes, etc etc etc. And let’s throw in the changing demographics and psychographics of our population – age, income, employment uncertainty, frequency of moving, disposition to owning vs. renting, and how everyone is processing the never-ending stories that seem to come out of the media and our politicians.
OK, enough of all that…back to predictive models and forecasting. How many variables mentioned above are taken into account in the Zillow predictive model on home prices?? Are they using U6, not U2 unemployment numbers? Are they considering the shadow inventory of REOs and the affect this has on local inventory and prices, and when lenders might dump them back into the market, disrupting both inventories and prices? What are their assumptions on the FEDs policies and how long they will keep interest rates artificially low? Are they accounting for the dramatic volume of purchases by hedge funds, and how that affects local inventories and prices?
I honestly do not know the details of how Zillow accounts for all the data relationships in their model, but I hope they consider more than U2 unemployment numbers, basic inventory numbers of listed homes, current interest rates, and average sales price.
Point is, there is a LOT to consider in developing a predictive model, and there are often many underlying factors to consider. Only a few (unpopular) economists predicted the extent of the real estate bubble and its unsustainable track. And even fewer can predict its recovery, given the introduction of many more pervasive underlying factors that were not considerations a decade or so ago. The real estate market is in unchartered territory…be careful about any predictive models…and be careful what you read in the media!