By Dirk van Dijk
In August, Existing Home Sales ran at a seasonally adjusted annual rate of 5.03 million. That pace is 7.7% higher than in July, and 18.6% above the year-ago rate. The year-ago numbers were extremely depressed due to the end of the homebuyer tax credit (a bigger issue in July than August, but still an issue). Thus, do not pay to much attention to the year-over-year number.
The August sales rate was far above consensus expectations of a 4.70 million annual rate. The history of used home sales is shown in the graph below (from http://www.calculatedriskblog.com/).
click all charts to enlarge
Results by Type of Home
Sales of single-family homes were up 8.5% on the month to a rate of 4.47 million, and are up 20.5% year over year. The median price of a single-family home nationwide fell 5.4% from a year ago to $168,400.
Condo and co-op sales were up 1.8% on the month, and are up 8.3% year over year. The median condo price fell 3.3% from a year ago to $167,400. For all existing homes, the median price was down 5.1% to $168,300.
Results by Region
Regionally, sales were up in all of the four Census regions, both for the month and year over year. The Northeast fared the worst, but that could have been because of the impact of Hurricane Irene, with sales up 2.7% for the month and a 10.0% rise from a year ago. The West had the best month-to-month increase, with sales jumping 18.3% from July and up 20.6% from a year ago.
In the Midwest, sales rose 3.8% for the month and are up are up 26.7% year over year. The South, the largest of the four regions, saw a 5.4% rise on the month, and a 16.9% year-over-year rise.
Median prices fell in all four regions. The big increase in the West seemed to come from houses going on a clearance sale, as the median price plunged 13.0% from a year ago to $189,400. The Northeast is the most expensive region, with the median home going for $244,100, down 5.1% from a year ago. The Midwest, already the cheapest area of the nation to live in with a median price of $141,700, saw a year over year decline of 3.5%. Prices in Dixie dropped 0.8% from a year ago to $151,000.
The median price is not the best measure of housing prices, as it is affected by the mix of houses being sold, but the data is basically consistent with what the better -- but less timely -- measures such as the Case-Schiller index have been indicating. However this drop is steeper than what we have been seeing of late from the Case-Schiller index, and I would guess when the August Case-Schiller data comes out it will also show accelerating declines on a seasonally adjusted basis.
Used Homes Sales vs. New Home Sales
The level of activity in used home sales really is not that important in isolation. It is just the transfer of an existing asset, and does not add a lot to economic growth. The one exception to that is realtors' commissions. Indirectly, it can help as people will often remodel and redecorate a “new for them” house. That can stimulate some sales for paint companies like Sherwin Williams (SHW) and perhaps it is good for furniture firms like La-Z-Boy (LZB), but it pales compared to the economic activity generated by a new home sale.
New homes not only need new paint on the walls, but they need the walls. That means lots of business for wallboard firms like USG, timber firms like Weyerhaeuser (WY) and roofing and insulation firms like the Johns Manville division of Berkshire Hathaway (BRK.B).
It also means that those firms have to hire more workers, so the employment effect of new home sales goes well beyond the roofers and carpenters actually on the jobsite. Also, the newly employed construction workers will have money in their pockets to spend, and as they do, that will stimulate other jobs.
Where used home sales are important is in relation to the inventory of houses for sale. That will influence the future direction of hosing prices. Used home prices are extremely important. As used home prices fall, more and more people find themselves underwater on their mortgages.
As long as a homeowner has positive equity in their house, the foreclosure rate should be zero. After all, it is better to simply sell the house and get something for it, rather than simply let the bank take it and get nothing for it. The more people under water, and the deeper they are, the higher foreclosures and strategic defaults are going to be. A strategic default is when someone has the cash flow available to continue to make his mortgage payment, but simply decides not to, since paying would just be a plain stupid thing to do from a financial perspective.
If you have a house that could only sell for $150,000 n the current environment, and you owe $200,000 on the mortgage, in effect you have the option of “selling” the house to the bank for $200,000 simply by stopping writing the checks. Of course, you will take a hit to your credit rating, but $50,000 is probably worth a bit of a tarnish on your FICO score. If the difference is only $5000, then the hit to your credit score makes less sense, and there are lots of non-economic factors (a house is, after all, a home, not just an investment) that come into play.
In July, inventories fell by 3.0% to 3.58 million. The decline, coupled with the increase in the sales rate, caused the months of supply figure to fall to 8.5 up from 9.5 months in July. While that decline is very welcome news, it is still a very high level. A “normal” months of supply is about six months, and during the housing bubble just over four months was the norm.
Also, the inventory numbers are not seasonally adjusted, even though there is a seasonal pattern when they tend to decline in the winter (especially around the holidays) and then increase in the spring. Year-over-year inventories are down 13.1% and this is the seventh month in a row that inventories have been lower than a year ago.
The second graph (also from http://www.calculatedriskblog.com/) traces the months of supply and the year-over-year change in inventory. The level still suggests downward pressure on existing home prices over the next few months. The year-over-year drop in inventory is somewhat encouraging, but the level of inventories has to be viewed relative to the sales pace.
Home Prices Finding a Bottom
Fortunately, relative to incomes and rents, home prices are not as absurdly overvalued as they were then, so the magnitude of the coming price declines is likely to be a lot less over the next year than the 30% plunge in 2008 and early 2009. I suspect they will fall by about 3% from here (as measured by the Case-Schiller index), and will probably bottom out by the end of the year.
Still, that could do a lot of damage, since the equity cushions are a lot smaller now than they were in 2007 or early 2008. If housing prices fall more than 3%, then lots of people with razor-thin current positive equity will also be underwater, and lots of homes that are only slightly underwater (where non-financial considerations tend to dominate) will become deeply underwater (where those considerations increase).
There are some very well respected housing economists, including Robert Schiller (creator of the Case-Schiller index), who are far more pessimistic than I about the future of housing prices, thinking prices could drop 20% or more from current levels. While that is possible, especially if the austerity mania that is sweeping Washington results in a substantial slowing of the overall economy.
That now seems very likely. While I don’t think that a new recession is the most likely scenario at this point, the odds are rapidly rising to about one in three. If we do fall into a new recession, Dr. Schiller could be right.
The next two graphs (also from http://www.calculatedriskblog.com/) track housing prices relative to the two most important drivers of housing prices: rents and incomes. They are not updated with the latest data, but still show important long-term trends.
My forecast of a further 3% decline would put prices roughly in the middle of the range where they were in the 1990’s. Dr. Schiller’s would put housing prices at the very low end of that range. I would say the risk is more that Dr. Schiller has it right, rather than we are both wrong (and him very wrong) and housing prices start to rebound in the near term.
I would also note that apartment vacancies have been declining recently and that will likely lead to increases in rents, which will also tilt the rent vs. buy decision in the favor of buying. Rising rents have started to show up in the CPI data, up 0.4% in August the biggest increase in rents in well over two years. Owners Equivalent Rent, by far the largest part of the CPI also rose 0.2%.
However, with falling home prices it is likely that the pace of foreclosures will pick up again. Even with the slowdown in foreclosures, the number of homes that are now owned by Fannie, Freddie and the FHA is mounting as can be seen in the next graph (again from http://www.calculatedriskblog.com/). Those institutions have no use for those homes and they will go on the market, often at very aggressive prices, putting downward pressure on the market.
Most of those who are being foreclosed on have indeed fallen far behind in their mortgage payments, and so in that sense the foreclosures are legitimate, even if the paperwork is a mess. The combination of underwater homes and reduced cash flow from one or both of the breadwinners in a family being out of work is a toxic mixture for the health of not just the housing market, but the economy as a whole.
Welcome & Encouraging Report
This was a very encouraging report. The drop in inventory is a very welcome development, although we still have a long way to go. A 8.5 months of supply is still high and points to continuing downward pressure on existing home prices, but less so than in recent months. On the other hand, the damage is done, as we saw with the sharp drop in median prices from a year ago.
The huge glut of existing homes on the market -- and the shadow inventory of homes that is likely to be foreclosed upon and thus come to market in the near future -- means that we really have very little need to build new homes. Thus residential investment, the historical prime locomotive in pulling the economy out of recessions will stay derailed. The jobs not created by a rebound in housing construction will mean that household formation will stay depressed, thus further depressing the demand for housing.
To put that in more concrete terms, young adults will not be able to get a job and form a family; instead, they will continue living in mom and Dad’s basement rather than soak up the existing housing inventory. A nasty "chicken and egg" situation.
The most important part of this report is what it says about the future direction of home prices. There the news is still bad, but at the margin, is getting better. In terms of economic activity and growth, the far more important report -- New Home Sales -- comes out next week.
New home sales have been slammed much harder than existing home sales. In normal times, there is about a 6:1 ratio between existing and new home sales. In July, that ratio was 15.7 to 1. I don’t expect much of a bounce in new home sales, and they well remain at near-record lows.
The next graph is only through July since we don’t have the August New home sale numbers yet, but assuming new home sales at a 300,000 rate (in line with what we have been seeing all year) then the ratio for August would be 16.8 to 1. I suspect it will be a long time (perhaps until 2015 or so) before we return to that historic 6:1 ratio.
Still, that would imply an annual rate of new home sales of 793,000 based on the current level used home sales, even over a four-year recovery period, so that still works out to a very strong compounded annual growth rate of 45.4%. That will be an important factor in overall economic growth going forward.