It seems like everyone in the Chicago area is trying to time the real estate market these days. Sellers are holding out for higher prices, convinced that the market is going to turn around any day now and they are going to make 50% on the home they bought 5 years ago. Buyers, on the other hand, are waiting on the sidelines for sellers to capitulate on their asking prices, fearing that they might otherwise buy a house that goes down 10% within the first year. The question on everyone’s mind is whether or not home prices in Chicago have bottomed out yet.

In general, trying to time any market is a risky proposition since you don’t really know until after the fact whether or not you bought at the bottom or sold at the top. It’s especially tricky with real estate because you have to really time the size of your mortgage payment, which is a combination of prices and interest rates. It doesn’t do you any good to buy at the bottom if interest rates have jumped up and more than offset the impact of declining prices. For instance, from May to June interest rates have shot up 60 basis points, which is enough to raise your mortgage payments by 6.6%. I also maintain that you shouldn’t look at a house as an investment in the first place because first and foremost it’s a place to live. Do you really want to spend the next 7 years of your life in a house that you picked based upon its assumed appreciation potential?

But let’s move beyond how I think you should be looking at the Chicago real estate market and let’s try to answer the question you are going to ask anyway. I can offer you three different sets of data that might shed some light on where Chicago is in the home price cycle.

First, the stock market is usually pretty good at predicting the future. Stock prices usually reflect what is about to happen to the economy, bottoming in advance of an economic bottom. For this perspective we can look at the S&P Homebuilders index over the last 5 years.

As you can see this index peaked in the first half of 2005 so it did a pretty good job of predicting the housing meltdown more than a year in advance of the peak. Unfortunately, there is no evidence that it has bottomed out yet. The groundhog has seen it’s shadow.

Another financial market that provides a glimpse into the future is the futures exchanges. It is often said that the best weather forecast for Florida comes not from the national weather service but from the orange juice futures market. For Chicago home prices we can look at the futures prices for the Case-Shiller home price index for Chicago, which show a decline until sometime in 2010. As of April the index was at 150.4 and the May 2010 value is 125, which amounts to a projected 17% further decline over the next 2 years. But one has to be careful in leaning too heavily on futures prices. Although the futures markets might be the most accurate forecast on average that doesn’t amount to always being accurate. For instance, for the past year oil futures have been predicting flat oil prices out into the foreseeable future and you all know how accurate that forecast has been.

Finally, if we go back to the long term trend in Chicago housing prices we can see that home prices overshot the long term trend for several years. By looking at the deviation of prices from the long term trend one can conclude that prices should come down by an additional 13%.

OK. So there you have it. Three different techniques that all say that Chicago home prices have not bottomed. Of course, that doesn’t mean prices will come down further. All 3 of these prediction methods could be wrong. Furthermore, even if it is true that prices are still too high they don’t necessarily have to come down in order to get back in line with reality. They can simply stagnate at this level until inflation catches up with them. It all comes down to how quickly sellers get real.

One more note for the sophisticated investor. If you really want to speculate on the direction of housing prices in Chicago or if you want to protect yourself from future price changes you can buy or sell the Case-Shiller futures on the Chicago Mercantile Exchange. For instance, if you want to sell your house but think that prices are going up in the future you could go ahead and sell at today’s price and then buy futures which will gain if home prices in fact go up. That way you can separate the investment aspect of home ownership from the living aspect.

Anyone who is savvy enough to shop around knows that the old adage “you get what you pay for” is simply not true. The fact that many people still believe it to be true creates job security for the marketing gurus since the whole purpose of marketing is to create perceived value that is substantially greater than the actual cost of producing the product. I remember when I was a Booz, Allen consultant and we did a study for Heileman Brewing. As I had always expected, the same beer was sold under different names with drastically different prices. More telling was the fact that around 60 - 70% of the cost of a beer was in the packaging and the marketing. The beer itself was a minuscule portion of the cost, with transportation taking up the another big chunk. Marketers understood that it was better business to spend the money on marketing than the underlying product.

Continuing with the alcohol analogy a bit further, my attention was grabbed a while back when I read an April 28, 2008 BusinessWeek article about how the advertised price of a wine influenced people’s perception of the taste. In an absolutely brilliant experiment by the Standford business school and Caltech, which was published in the Proceedings of the National Academy of Sciences, researchers showed that when tasting the exact same wine under two different price tags subjects liked the wine with the higher price tag. Go figure!

Not only was this their stated preference but MRI scans on these subjects actually confirmed increased activity in their prefontal cortexes as shown in the graph below:

So the connection with real estate should be obvious at this point. If a real estate brokerage spends a lot of money on advertising an upscale image and charges a high commission, chances are that people will believe that the service they receive from such a brokerage is better. However, that isn’t necessarily the case - the wine or the beer may be exactly the same.

Now, if you think you may be susceptible to the marketing ploy of the traditional brokers we would be more than happy to provide you with our Platinum Premium Exclusive Diamond Plus service and charge you accordingly.

While the housing market is hurting in most parts of Chicago, Lakeview mysteriously remains somewhat immune. Not too long ago Crain’s ran an article which showed data calculated by Fiserv Lending Solutions which calculated the Case-Shiller index down to the zip code level for 76 different zip codes in the Chicago area where they had enough data. Their analysis showed that home prices had declined last year in all of those zip codes except for 6 and Lakeview (essentially 60657) was one of them. In fact, the Fiserv analysis shows Lakeview home prices actually increasing by 4.6 - 6.0%. And this is not the flimsy median price analysis that I often complain about when I see it in the Chicago Tribune. It’s a far more accurate analysis based upon sequential sales of the same homes over time.

This seems to be consistent with a recent analysis of Lakeview condo prices I did myself as part of a listing presentation for the same zip code:

The data shows that the months supply of inventory (for 2-3 bedroom and 2+ bathroom condos) for Lakeview is actually slightly better than it was a year ago. The only signs of strain are in the number of days on the market for condos that go under contract, which is trending upward.

Frankly, I’m baffled by this. With the huge and growing condo glut in the city and all other zip codes experiencing deterioration how long can Lakeview remain isolated? I lived there myself for a while and it’s a great community but doesn’t Lakeview real estate compete with surrounding communities that are offering better and better deals all the time?

For more current data on the Lakeview real estate market visit our Lakeview community profile page.

In my financial blog I just posted an article that is pertinent to the world of home ownership. The gist is that it usually doesn’t make sense to pay down your mortgage.

With the extreme shortage of real estate in Chicago (yeah, right) I guess it should be no surprise that developers are scooping up every available scrap of land for housing developments.

The Union Row development in the 600 block west of 16th. street may signal a new trend in the gentrification of underpasses and railroad tracks. Check out these photos of the spectacular view of The Dan Ryan and the railroad tracks from these townhomes:

As you can see, the railroad tracks will provide hours of entertainment for the myriads of children who will play on them, while the homeowners will literally be a short walk from all major forms of transportation.

The underpass will also provide great shade during the afternoon sun, saving lots of cooling dollars during the hot summers.

This view from the underpass should remain unobstructed until a developer decides to actually build a house under the underpass.

Even with the back fence folks will be able to see the train tracks and the Dan Ryan. No need for these folks to get a traffic report in the morning. All they have to do is look out their window.