AEI Market Trends Report (MTR) FAQs (v. 1.19.2020)

1. Why be concerned about price versus value?

Prices are driven by supply and demand and therefore may prove to be volatile and speculative, while values are determined by trends related to market fundamentals: rents, construction cost, new supply, and wages. If all borrowers paid cash or put down a substantial down payment, our interest in and concern over this difference would be much less. But in today's home finance market, leverage matters, in particular because it can have a large impact on price.

The following are core principles of housing finance that were articulated in the first half of the Twentieth Century:

This two, from 1903, are the most important:

• Since value depends on location, & location on convenience, & convenience on nearness, the intermediate steps may be eliminated & say that value depends on nearness. ¹
• If a new utility does not arise, [sales] prices may advance and recede, while intrinsic values do not change. If a new utility arises, both [sales] prices and intrinsic values will alter their levels. ²

The next five provide additional insight:

• [s]peculative elements cannot be considered as enhancing the security of residential loans [rather they] enhance the risk of loss to mortgagees [if] permit[ed] to creep into valuations...³
• Because situations of scarcity [seller's market] or over-supply [buyer'smarket] do not last indefinitely they cannot be considered as phenomena the affect valuations for long-term use... and not truly indicative of value for mortgage insurance purposes. ⁴
• The sequence of [market cycle] events is fairly predictable, though the period of the phases of the cycle and the amplitude of the variations are not subject to dependable forecasting. ⁵
• The essential nature of housing demand is changeability; the nature of housing supply is rigidity. ⁶
• [I]n a seller's market, when choice is restricted and the seller virtually dictates sales terms, more liberal credit is likely to be [capitalized] in price with probably a reduction in housing standards. ⁷

• ¹ Hurd, The Principles of City Land Values, 1903
• ² , Ibid.
• ³ FHA 1938 Underwriting Manual (main authors: Ernest Fisher and Frederick Babcock)
• ⁴ FHA 1947 Underwriting Manual
• ⁵ Ratcliffe, Urban Land Economics, 1949
• ⁶ Ibid.
• ⁷ Fisher, Financing Home Ownership, NBER, 1951

2. What trends are fundamental to reconciling the subject property's market Price to its intrinsic home value?

Intrinsic Home Value refers to the value of a home determined by analyzing fundamentals without reference to its market price. The first three charts relate house price appreciation associated with the subject property's price tier to (i) construction costs, (ii) wage growth, and (iii) rents. The fourth chart relates the subject property's house payment to its rental value, which provides a measure of its ability to earn its way out the mortgage debt.

• Construction costs
• Wage growth
• Rents
• Housing payment to rental value (relevant to the low and low-medium price tiers which are at entry level price points and where demand comes largely from first time buyers)

3. What trends are fundamental to evaluating speculative forces that may be impacting home prices?

Speculative elements drive up the market price to a level well above the intrinsic value. This higher market price relative to intrinsic value should be considered by the lender as speculative elements enhance the risk of loss should the price recede closer to intrinsic value.

• Home sales trends
• Supply/demand (month's inventory of existing homes divided by current sales rate)
• Constant quality home price appreciation
• Mortgage risk
• Weekly interest rate trend
• New construction sales

4. Why does the Market Trends Report focus heavily on price tier?

Our research has found that home price appreciation, supply and demand, mortgage risk, and new construction supply are all sensitive to price tier within a local market. In terms of price tiers, the MTR uses either entry level vs. move up or low, low-medium, medium-high, and high, both by market.

Market by market, lower price tiers consistently have these correlations:

Higher home price appreciation

Note: The entry-level segment consists of the low and low-medium price tiers and the move-up segment consists of the medium-high and high price tiers.

Lower month's remaining inventory during a boom, reflective of a supply/demand imbalance ⁸

Higher mortgage risk

⁸ Month's inventory at current selling rate is generally inclusive of other indicators such as: days on market and inventory of listed properties. Other indicators such as: how many listings have been withdrawn, foot traffic, how many listings have been reduced, and cancelled appraisal orders; may be useful in developing an opinion on whether a long term market trend is changing.

Lower additions to supply as a result of new construction

5. Why has this type of report never been done before?

A massive amount of granular data had to be compiled from a wide range of sources. Those data then needed to be turned into market trend information, that would allow the user to analyze the information and develop an opinion regarding the relationship between price and value.