The most recent results from the Case-Shiller Index published last week suggests that through March of 2014, home prices were starting to visibly slow from the torrid, double digit rates of home price appreciation (HPA) seen over the past two years and more. Whereas in the last year HPA was more than 12% or 1% per month, in the first quarter of 2014, the National Index gained just 0.2%. Nineteen of the 20 cities in the index showed positive returns in March, but New York declined. 

Not surprisingly, fast growing regions like Dallas and Denver reached new index peaks.

The Case-Shiller press release stated: “In March, the National and Composite Indices saw their annual rates of gain slow significantly. Chicago showed its highest year-over-year return of 11.5% since December 1988. Las Vegas and San Francisco, the cities with the highest returns, saw their rates of gain slow to approximately 21%; their post-crisis peak returns were 29.2% and 25.7%, respectively. At the lower end was Cleveland with a gain of 3.9% in the 12 months ending March 2014.”

But the fact that the Case-Shiller Indices are still showing positive HPA does not mean that home prices are still rising generally around the US. In fact, many professionals in the mortgage industry believe that home prices actually peaked last summer. But the Case-Shiller Indices, which are based on average home prices, tend to overshoot the change in direction of home prices, both on the upside and on the downside. Simply stated, the continued appreciation of some housing segments, for example, high-end homes in San Francisco, or distressed sales in the southwest, tends to mask the fact that HPA in many parts of the country has slowed or may even have reversed direction altogether.

A new home price index created by the co-founder of the Case-Shiller index, Allan Weiss, addresses this lack of visibility as to the directional movement of home prices by looking at the prices for individual homes rather than averages at the zip code level. Instead of showing 5,000 averages in zip codes around the nation, the product created by Weiss Residential Research shows 50 million individual home prices presented as consistent indices based upon factors such as square footage and the vintage of the home.

Through the end of March 2014, the data from Weiss shows that home prices for 1,000 square foot single family homes have fallen -1.1% in Chicago to -2.4% in New York. Relatively hot markets such as San Diego, Miami and Los Angeles were also down, albeit to a lesser degree, while Phoenix was unchanged.

Looking at the largest homes, above 4,000 square feet of living space, prices were likewise down from -2.4% for Atlanta to -1.8% for New York and -1.1% for Los Angeles.  What the Weiss Residential Research Data suggests is that the turn in relatively less attractive properties that was detected last summer has now spread to a more generalized downturn in home prices.

Home prices tend to change direction slowly, over a period of many months. When a change in direction occurs, however, the housing market tends to move in the new direction for a long period of time, usually years. Both the Case-Shiller and Weiss Residential Research data confirm this reality, but each data series shows different perspectives on the movement of home prices. 

The more difficult question for many observers to understand is why home prices are starting to soften now.

First and foremost, it is important to remember that the positive HPA seen over the past two years was a result of the beginning of the end of the massive sale of foreclosed properties by banks.  About half of the ~12% increase in HPA observed by indices such as Case-Shiller and Weiss Residential Research between 2011 and 2013 was due to gradual elimination of the discount for REO sales compared with retail home sales.

The second significant negative in today’s market is the still high percentage of cash buyers, some 40% nationally and upwards of 70% and more in markets like Miami, San Francisco and New York City. Many of these markets benefit from capital flight from troubled regions around the world, but with the ebbing of the easy HPA, even these markets are showing signs of slowing. 

Most domestic investors in US real estate, it is important to remember, are not large institutional investors, but instead individuals and small investment firms who are sensitive to whether HPA is likely to be positive in the future. The offshore buyer is significantly less sensitive to short-term HPA than are US investors, however, since they are seeking to shield cash from unfriendly authorities in their home nations.

The third and most troubling reason why prices for US homes are likely headed for a period of weakness is the poor economy, including weak job growth and consumer incomes, the latter of which are actually negative in real terms. The lack of employment opportunities has stifled the formation of new households, one reason why some of the most bullish prognostications by economists and housing analysts regarding “pent up demand” have been proven badly wrong. New mortgage originations are running at less than $1 trillion annually, about a quarter of the peak levels of a decade ago. Rising mortgage rates and continued tight lending standards only add to the challenge for consumers.

The housing boom of the 2011-2013 period was not a normal example of home price recovery, but rather a spasmodic reaction to the process of working through millions of foreclosed homes in the wake of the subprime bust. The fact that home prices were rising 5-6x GDP growth suggests that the upswing was unsustainable. 

Again, more than half of the HPA seen over the past 24 months came about because of the sale of REO properties to cash buyers, not because new families were starting new households and getting mortgages. 

We may have a long, long way to go before the US housing market starts to deserve the term “normal” once again.