Holy Grail -- Watch Out!

Investors in stocks and commodities have an uncanny ability to always search for the holy grail, the magic bullet, the easy way to riches (or decisions). Lately even home buyers and real estate investors have been seen looking for one.

Only a few years ago (2001 for the expanded city list), Robert Shiller and Karl Case, economists at Yale and Wellesley, respectively, developed an index they call the Case-Shiller Home Price Index. This index computes home values for 20 major metropolitan areas around the country and conveniently boils it down to a single composite number like the price for a barrel of oil.

Shiller's and Case's purpose in this was to license the index exclusively to a firm, MacroMarkets LLC, founded by Shiller for "developing, structured and trading financial instruments" mentioned on the web site. Options and futures on the index are traded on the Chicago Merchantile Exchange (CME) to directly invest in and hedge U.S. housing.

As you may know, you can purchase options and futures contracts on virtually anything you can think of -- stocks, commodities, and yes, even indexes, like the S&P 500. There is no reason that an index on real estate prices should be left out.

The only problem is that some would-be home buyers and real estate investors are using this index (or a separate one for a metro area) as a decision tool to time the market. What's more, they even heed Shiller's forecasts calling for scary, 30% plus drops in housing prices which he told the Associated Press last month. Shiller doesn't know what prices will do and neither does anybody else.

There are a couple of flaws I see in the use of something like this to help someone make a decision. The first of which is that the index is calculated on a three-month moving average and released with a two month lag. This means that the May's report is releasing March's information. The second flaw is that using a broad-based index to make a decision for a particular community or neighborhood will likely produce an incorrect assessment and a wrong decision.

Remember the wider or broader you go in the information pool you use for real estate trend analysis, the greater the potential error you build in for a particular area under consideration. Now, I'm not an advocate of the "flying by the seat of my pants" style of analysis but am a proponent of highly-focused research into the market dynamics of the area of interest in as small an area as practical. I provide clients market intelligence information on trends, trend changes, supply and demand at the neighborhood level in order for them to make a better decision to either buy or sell.

Personally, I use indexes all the time and will even use the Case-Shiller when I want to trade the index. After all, its easy to get an indication of general stock price movements by what the Dow Jones Industrials or the NASDAQ averages did. But would you use that input to make a decision to buy or sell a particular stock? I hope not! Same goes for real estate. When I'm advising a client contemplating making a change, let's say, in Willow Glen, then I'll research Willow Glen, not use as the basis of my advice the Case-Shiller index for the entire San Francisco metropolitan area. I'm afraid it wouldn't be relevant and of much help!

In Sunnyvale, there are presently three distinct market areas and each of them pose an opportunity to understand so that the proper strategy can be applied. I wouldn't advise approaching the market in one area of Sunnyvale, for instance, with an indicator that is constructed of information related to markets in San Francisco, Oakland and Fremont.

Thanks for reading!