Economists' Commentary: Pending Home Sales in December
February 3, 2009
By Lawrence Yun, Chief Economist
Contract signings to purchase a home rebounded in December after taking a sharp hit in November. The latest index of 87.7 is an increase of 6.3 percent from November after accounting for seasonal factors and is higher by 2 percent from one year ago. It is by no means a time for celebration. Recall the November reading was the lowest reading ever of the series since its creation in 2001. Pending home sales is a leading indicator for home sales closings by a month or two, but the January closing sales, which will be released later in the month, are hard to predict given the very weak November pending sales and some partial rebound in December. Also due to sampling differences, with pending data roughly half the size of the closing data, that there will never be a direct one-to-one correlation between pending sales and closing sales.
Areas that are improving in terms of pending sales (but not necessarily in terms of price) can be found in many California and Florida markets. San Diego in particular is coming around very strongly, essentially doubling in contracting signings in December compared to the same month one year before. In the Northeast, Providence has been the consistent gainer over the past several months. More markets in the Midwest are appearing to turn around for the better with Akron, Cleveland, Lansing, Louisville, Minneapolis, and Wichita all posting year-over-year gains. Aside from Florida, Northern Virginia has been tallying up higher figures. Some nearby Maryland counties have also now joined the dance. Oklahoma City and Tulsa, where the job market has been doing better and home prices have always been highly affordable, have also posted gains.
The lagging markets were in Texas, North Carolina, Oregon, and the state of Washington. Honolulu has been losing sales, partly due to the relatively more difficult conditions for getting mortgages for condo properties. Home prices have been broadly rising in Texas despite falling sales.
Forecasting is a hazardous sport at times. With so many pieces of the puzzle now moving in opposite directions, the crystal ball reading has become even cloudier. Job cuts have been severe, with 2.5 million lost already, but affordability conditions are at the highest in nearly 40 years. Mortgage rates are at historical lows, but obtaining an approval has become a lot more difficult. Even FHA loans are putting up tighter conditions for homebuyers, even those that are not overstretching. In the past, a person with a reasonable credit score and paying not more than 30 percent of their income on housing would have easily been approved for an FHA loan, precisely because of the government guarantee. That is not the case today - according to many REALTORS® that I have spoken to. The consumer confidence is in the tanks but sweet, enticing home buying incentives will be included to precisely offset the weak confidence in the economic stimulus package (though the details are still being ironed out).
Having presented the qualifiers, I project soft existing home sales in the first quarter before steadily trending up later in the year. By the fourth quarter, existing home sales could be easily 10 percent higher than a comparable period the year before. Rising home sales will be critical to trimming inventory, including the new foreclosed properties that will be reaching the market in 2009.
Because of continuing soft home sales for at least few additional months, the inventory will remain bloated and pressure home prices to be weaker over the next six months. It should be noted that the current lower price reading is partly driven by more sales activity in low-priced neighborhoods and many fewer sales in higher-priced neighborhoods. The problems in the jumbo mortgage market have stalled activity on the upper end.
New homes sales will be much more challenged, with sales barely above 300,000 in 2009. That will be the lowest ever since the Great Depression era and a severe cut from the 1.2 million new home sales in 2005. The record low new home sales just reflect a collapse in home building activity. The December housing starts were 550,000, the lowest since the data collection in the 1950s. Builders are squeezed. If they dig and build, they will likely lose money in the current environment. If they don't build, they don't make money. Of the two hard choices, the builders are choosing the latter option.
Despite the extreme financial pain surrounding the homebuilders, the housing market is moving in the right direction as a result of less new home construction. The inventory of new homes reached a high 12.9 months in December, but that was driven by the very low sales activity and not due to a pickup in empty new homes on the market. What was less noticable was the actual decline in the raw number of new homes on the market. In December, there were 357,000 new homes for sale, marking nearly two straight years of a steady decline. If new homes sales pick up by any measurable amount, the months supply will easily fall under 10 months or even possibly to 7 or 8 months. The rate of demolition is now likely to be higher than new homes being built. Therefore, the inventory can get into balanced situation quickly given the 3 million population growth in the U.S. every year.
The economic assumptions are that the Federal Reserve will hold pat and keep the fed funds rate at essentially zero for the remainder of the year. The economy is in a harsh recession and consumer prices will actually fall in 2009. The Fed has no worries on the inflation front, thereby affording it to keep rates low. The 10-year Treasury will remain under 3 percent, while 30-year mortgage rates will average close to 5 percent. A stimulus plan being discussed at the time of this writing is to get mortgage rates near 4 percent, but this assumption is not in the forecast. The Fed should, however, be very mindful to keep a watch on inflation just in case. With so much liquidity pumped into the system, a modest pickup in the velocity of money could quickly push inflation to an uncomfortable zone. High inflation will lead to high mortgage rates. Inflation must be nipped quickly should it appear.
The jobless rate will rise close to 9 percent before the positive impact of a stimulus package kicks in. That will correspond to about 4 million net job loss from the peak employment at the end of 2006. The stimulus will be expensive, but needed to turn the economy around. However, if it is not done properly, the economy will have only gotten a short-term boost without a long-term sustainability at the cost of a $1.5 trillion budget deficit. Another year of such a deficit will greatly hurt the U.S. dollar and lower the standard of living for Americans. President Obama in a sense has one shot at getting it right. His plan is fittingly bold, but he should not try to push for measures that do little to stimulate the economy.
As I have said many times, in my view the economy simply cannot recover without the housing market. Falling home prices are justified to bring it back in line with what can be justified by fundamental factors. But a downward overshooting of prices will harm consumer spending due to the negative housing wealth effect and could easily lead to a second round of a major credit crunch as bank balance sheets worsen further from falling collateral values. Another round of TARP funding may then be needed on top of the $1.5 trillion budget deficit - a thought that I do not want to entertain. Therefore, a measure to stabilize home prices must be aggressively pursued. That includes modifying mortgages to lessen foreclosure pressures and, more importantly, getting a new set of buyers into the market to soak up the inventory. Give buyers incentives through low mortgage rates, including lowering jumbo mortgage rates through the Federal Reserve credit facility, and a homebuyer tax credit without the repayment feature.
I am hopeful overall that the stimulus package will contain strong housing stimulus components. The economy will then recover in a sustainable way. The budget deficit will steadily get trimmed as more workers pay taxes rather than collect unemployment benefits. America can and will survive through this mess and it will soon be morning again in this great nation.
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