Misleading Charts In The Media : Foreclosures Versus Home Prices

This is a chart from RealtyTrac's Q1 2008 Foreclosure Report. It is misleading.

A common conclusion that people make from charts like this is that foreclosures are the cause of falling home prices.

That's false. There may be a relationship between the two, but one doesn't necessarily cause the other.

Home prices fall when the supply of homes outweighs the demand for homes.

Yes, foreclosures can increase the amount of homes for sale in an area, but the demand-side of the equation is equally important as a predictor of home values.

Supply and Demand is the basis of all pricing.

Now, some parts of the housing demand equation are constant from season to season -- families outgrow their homes and move-up to larger ones; or desire a specific neighborhood in which to raise childen; or downsize into retirement.

Other parts of home demand, however, are elastic.

For example, when the economy is sluggish, the number of real estate investors tends to diminish, as does the number of people asked to move for job-related reasons.

This slows the influx of buyers to a region, city, or neighborhood and places downward pressure on home prices.

And falling Consumer Confidence impacts demand for homes, too.

When Americans are dubious about their economic future, they tend to play it safe(r). Unsettled about financial prospects, homeowners will often choose stay in their current home versus buying a new one.

Nationwide, consumer confidence levels are their lowest levels since the early 1990s.

And lastly, demand for home is subject to elements of psychology. Some people simply don't like buying into a market they perceive to be falling. Ironically, that becomes a self-fulfilling prophecy and the market spirals lower.

Because of the perceived Cause-Effect relationship between foreclosures and home prices, people like to cite a foreclosure "statistic" that's really just an observation. The common belief is that for every foreclosure in a neighborhood, nearby home values lose 1 percent of their value.

This is untrue because there's no evidence that values fell because of the additional home supply. It's more likely related to the demand for homes. In other words, there may be a relationship between the defaulted mortgage loan and falling values, but it's definitely not a direct one.

Home values fall for the same reason that foreclosure levels rise -- there's not enough buyer demand to cause otherwise.