We’ve stated it before and we’ll say it again: we are firm believers in Edward Leamer’s thesis that “Housing is the Business Cycle“. It continues to be the prism through which we view the economic cycle. It colors every investment idea we evaluate and how we position the PAA Research SMid Cap Portfolio.
In short, the significance of the US housing market for the global economy cannot be overstated. Despite its importance to the economy, we still think there is a dearth of quality information about real-time trends in the housing market. The monthly data series on new and existing home sales provide investors with a reasonable snapshot of the US housing market overall.
However, the national level data does not enable investors to effectively determine how various cross-currents such as foreclosure activity and credit availability are impacting trends. Additionally, the regional breakdowns (Northeast, Midwest, South, West), over simplify what is an increasingly complex and layered housing market at the state and regional level.
As a result, a number of third party research firms and state-based associations have attempted to step into the “information breach” to offer better data on trends in home prices, inventory levels, foreclosure activity, strategic defaults, and distressed sales. Most third party research we read tends to focus on former bubble markets such as Arizona, California, Florida, and Nevada. After all, those states have witnessed the highest level of sales turnover and arguably the greatest economic opportunity or loss, depending on which “side of the table” you have been on.
Despite the copious amounts of data available on the US housing market, we think investors are still left with an incomplete view of residential real estate, particularly in markets that were not big parts of the “housing bubble”. We wanted to learn more about the state of housing from people who “live it” everyday. Over the past several weeks we have conducted a survey of approximately 1,000 residential real estate brokers across the country to gain a better understanding of the housing market from a bottom-up perspective. The feedback from our survey significantly enhanced our understanding of the US housing market on a regional, state, and local market basis. We view this data as a step forward for those who are interested in having a more nuanced view on housing. The key findings from our survey include the following:
- The housing slump has transitioned from the bursting of the credit bubble to a more traditional recession/job loss induced downturn. The good news is: many properties in the most inflated markets have switched from weak hands to strong, affordability in many markets is at or near highs, and home buyers have returned to more traditional forms of financing. The bad news is: prices are still declining, inventory levels remain bloated, credit is tight, and the modest momentum built over the past years looks poised to stagnate following the expiration of the housing tax credit. Four years after the credit bubble burst, stabilization in the housing market appears as tenuous as ever and there is little evidence of a “V” shaped recovery in housing as some would have you believe.
- Prices are declining in most markets and the majority of the realtors we surveyed expect prices to decline over the course of the Spring/Summer selling season.
- Listings have increased significantly YOY and inventory levels remain too high in most local markets. Ironically enough, the one group of realtors who indicated that inventory levels in their local market were too low operate in California.
- Credit availability remains tight and has not improved meaningfully over the past 3-months. This is not shocking news to anyone. However we think many people will be surprised to learn that the vast majority of mortgages are underwritten with a 0-10% downpayment. At a time when strategic defaults are sky-rocketing, we cannot understand why lenders maintain relatively lax down payment requirements. A further 5-10% decline in home prices could render many buyers in the past 12-18 months with negative equity.
- Very few properties receive multiple bids and a small percentage of transactions close above the seller’s list price. We expected a higher percentage of realtors to suggest that more homes were receiving multiple bids given the stabilization in new and existing home sales. The feedback from our survey suggests that “caution” is a prevailing theme in most markets and it could take a long time for inventory to be fully absorbed.
- The appraisal process represents another obstacle for many sellers. Many of the brokers we surveyed have expressed concerns about the relative knowledge level of appraisers who are working in new markets and their willingness to use distressed property sales as a comp for a non-traditional sale. Brokers have an inherent bias against the new appraisal rules, but it is clear that a number of transactions have been delayed or cancelled due specifically to the appraisal process.
- There has been a quadfurcation of the housing market into four segments: distressed sellers, traditional sellers at lower prices, traditional sellers at higher prices, and new homes. Buyer appetite for distressed properties has been robust and even traditional sellers of lower priced homes have witnessed pockets of solid demand. However, higher priced homes (and “higher” truly is a relative term based on the market you are in) and new homes have witnessed a dearth of bidders and more acute pricing pressure.
- Banks, in many respects, control inventory levels at the local level. Many realtors we surveyed thought that inventory in their respective market could increase in the coming months as more banks “release” properties through short sales. Shadow inventory held by financial institutions continues to grow and it remains an overhang in most markets, not just in Arizona, California, Florida, and Nevada.
- Nearly 60% of respondents to our survey indicated that transaction inquiries and leads have declined “a little bit” or a “great amount” since the expiration of the housing tax credit. Based on this feedback it appears that the housing market could stagnate at best and enter another down draft at worst over the next several months.
Based exclusively on the nine points above, one could quickly conclude that the US housing market is devoid of positive trends, which is not the case. We would highlight the following positive observations from the data at a national level and the feedback from our survey:
- Realtors are generally optimistic about the prospects for housing over the next 6-months. Approximately 42% of the realtors we surveyed indicated they expect the health of the housing market to improve over the next 6-months, while another 30% expect it to remain the same.
- New home sales and inventory have reached trough levels and can only go higher from here. This implies that residential construction will transition from a drag on GDP growth to a modest benefit for the foreseeable future.
- The housing tax credit worked. Based on the new and existing home sales data for April, a number of buyers took advantage of the credit. Any initiative that transitions real estate assets from weak hands to strong should be viewed positively. Unfortunately, it does not appear that the housing tax credit will have the same broad reaching impact on inventory levels and the overall economy as the Ford tax credit did in 1975.
- Inventory levels in California have normalized to some extent. According to the realtors we surveyed, inventory levels have tightened in many markets. However, over the coming months we expect the pace of sales to slow and inventory levels to build.
Overall, we think the negatives outweigh the positives and more importantly we think slowing sales volumes over the next 3-6 months will “rule the day” and likely shape the tenor of conversation about the US economy for several quarters.
You can read the entire report on our website.
Disclosure: No positions