As I promised in part I of this series there is plenty to write about regarding how the real estate industry uses statistics to propagate lies and myths. Today I’d like to call your attention to an NAR sponsored Web site: www.housingmarketfacts.com, the goal of which is to talk up the real estate market. Nothing like an unbiased source of information.

Here are some of the “facts” found on this Web site:

More than three-quarters of all recent buyers believed their home purchase was at least as good as an investment in stocks. So…when three-quarters of the world thought the world was flat that made it true? It is incredible that they can even publish such a statistic. In the last 10 years this belief was probably justified but in the long run it’s simply fantasy. As I’ve pointed out before, in the long run, after adjusting for inflation, housing has had a zero return.

According to the 2007 NAR Profile of Home Buyers and Seller, first-time home buyers made a median down payment of 2 percent, while repeat buyers who financed their purchase put 16 percent down, indicating the wealth-building effect of homeownership. Well it’s bad enough that they even report this statistic in the first place but it’s really sleazy to add in their own, highly-suspect conclusion at the end of the sentence. In all likelihood the higher down payment has nothing to do with the wealth building effect of homeownership. It has everything to do with the forced savings of monthly mortgage payments and the fact that repeat buyers are older and more successful for other reasons. Do you think that maybe upwardly mobile consumers are more likely to move around?

Homeowners benefit from the power of leverage. Over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5% would return nearly 5 times the stock market return, at $110,300. Oh….my….God. This thing is wrong on so many levels I don’t know where to begin.

1. Their math is wrong, though directionally correct. The stock market return under their assumptions would be almost $26,000 and the return on the home would be almost $136,000.
2. 5% annual home appreciation is way too generous so there is nothing “normal” about it. For instance, for the 10 year period beginning in January 1987 the average appreciation for the 10 city composite in the Case-Shiller index was only 2.2%. At that rate the $10,000 down payment in their example only returns a bit under $59,000.
3. They are assuming 20 x leverage (5% down). You can leverage your stock investments as well and if you use 20 x leverage then that stock return would be almost $329,000.
4. Of course, using 20 x leverage is just not smart. It cuts both ways. If your investment goes down by 5% you are wiped out. That’s sort of what happened to people in the last couple of years.

I’ll save the rest for part III.

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.

This is Part I because I have a feeling that I am going to be writing about this topic for a long time.

Having spent a lot of time in past lives analyzing data to make business decisions I know how people often mistakenly use data or intentionally use them to misrepresent the facts. The real estate industry is ripe with examples of statistics used inappropriately and, frankly, I can’t tell if it’s just incompetence or maliciousness. Let me give you a few great examples.

Example 1

My favorite is the real estate industry’s often trumpeted “Research shows that in 2006, sellers who worked with a real estate professional sold their homes for an average of 32 percent more than homes that sold directly by their owners.” That particular quote is from the March 2008 issue of Realtor Magazine but I’ve seen variations of this quote all over the place. We’re encouraged to use it to convince sellers to use a real estate agent to sell their home. I guess they expect the cowering seller to immediately sign up for a 6 or maybe even 7% commission, which is a small price to pay for realizing a 32% higher sales price.

Excuse me? How stupid do they think we are? I don’t doubt for a minute that the statement and underlying statistics are 100% correct. And I also don’t doubt that a really good agent can get a higher price for a home than a seller can on their own. But 32%? Come on! As a REALTOR® I would be embarassed to tell a seller this.

So what’s really going on here? I think it’s pretty simple. People with more expensive homes are more likely to use a real estate agent to sell their home. This could be for any number of reasons:

• They have higher incomes and can afford to pay a commission
• The volume of home sales in their price bracket is lower so it’s a little bit harder to sell their home
• They tend to be older with larger families and have less time to spend selling a home themselves
• More expensive homes offer more fertile prospecting for real estate agents so they’re all over these owners

I think we’ve beaten this one to death.

Example 2

“Our brokerage’s sales volume is up X% over last year while all of our competitors have shown sales declines”. Again, this is intended to wow the unsuspecting buyer or seller into signing with that particular brokerage firm.

Well, I’m sure the data is correct but the implied conclusion is wrong. There are two problems with this statement:

• The number 1 way for a broker to grow is by recruiting agents from their competitors, so odds are that this is exactly what happened. I happen to know for a fact that the fastest growing broker in Chicago right now is growing exactly in this manner and is using the resulting data to try to market themselves.
• The implication is that when you sign with an agent you are somehow also benefiting from all the success of that brokerage. While that would be true of a firm that actually employs their agents, like ours, it makes no sense at all for a firm that uses independent contractors.

This issue of how brokers grow and the drawbacks of the independent contractor model are covered in more detail in our real estate industry white paper if you are interested.

This misuse of the data is endemic to the real estate industry. If it weren’t so pathetic it would actually be funny but at least it provides plenty of fodder for future blog posts.