In a recent article by Ken Harney (Washington Post Writers Group) on the rebound in home equity markets, he discussed a study by CoreLogic, which estimated that around 791k homes moved from negative to positive equity during the third quarter of 2012. Harney cites several ways that home equity can grow:
You lower your debt by making payments to your lender, the value of your house increases because market conditions improve, or you raise the home’s sales value by remodeling or upgrading it.
When you consider that home equity is one of the main ways that consumers finance remodeling projects, an interesting question of causality arises: can we forecast trends in real estate values by analyzing remodeling activities or are trends in remodeling activity the result of fluctuations in home equity?
To answer this question, we examined the relationship between the S&P/Case-Shiller Home Price index and our BuildZoom index of remodeling activity. For the sake of parity, we filtered our index to focus on types of remodeling more discretionary in nature (e.g. additions) while ignoring less discretionary types (e.g. HVAC, plumbing) and deseasonalized the index.
Here is the comparison (S&P Case-Shiller is blue and the BuildZoom residential remodeling index is red):
There was a high correlation between the two variables (R=.93) and we were unable to observe one trend leading the other over the 7-year period. The time series did reveal a greater degree of volatility in remodeling activity (%RSD=23) versus home prices (%RSD=15), which can be somewhat expected given the discretionary nature of remodeling.
Unfortunately, based on these two variables alone, we weren’t able to discern whether remodeling activity leads home equity (or vice versa) although more research into how remodeling projects are financed as well as more targeted analysis that ties home values directly to specific remodeling expenditures may shed some light on the topic.
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