Economists' Commentary: Pending Home Sales and Forecast
December 9, 2008
By Lawrence Yun, Chief Economist
October was an awful month for the economy, with the stock market tumbling and the job market sharply deteriorating. Despite that, there were home buyers signing contracts during the month. Pending home sales declined by only 0.7% during the month and were 1.0% lower compared to a year ago. Regionally, only the West region experienced a year-over-year increase in contract signings. California in particular has seen an exceptional turnaround in buying activity. Many foreclosed homes have enticed buyers to take advantage of deeply discounted prices.
Stable sales in light of what is happening to the rest of the economy do not look all that bad. However, stable sales will do nothing to reduce inventory, which is running still very high at more than 10 months supply nationally. Only a solid upturn in sales can meaningfully bring down inventory. Without inventory reduction, home prices will continue to remain under pressure. And falling prices will further lead to increased foreclosures and increased re-defaults on already modified mortgages.
NAR has been pressing the issue to focus on the demand side of the market, such as a mortgage rate buy-down, a home buyer tax credit, and a higher conforming loan limit. Providing the buyer with incentives will be important, because only the healthy buyers can clear off the high inventory of homes, and because they now have to meet tougher underwriting standards. By my calculations, an increase in home sales by just 10% (or 500,000) will bring months' supply to less than 8 months, the point at which home prices can stabilize.
Furthermore, stable home prices are a necessary condition to rein in foreclosures. Foreclosures will keep rising if prices keep declining. But shouldn't the prices come down after the exuberant rise during the boom years? By my calculations, home prices have already fallen to what they should be and any further price collapse will cause collateral damage to the economy. Consider the height of the boom in 2006 - things were completely out of whack. Home prices were up by 64% from 1998 (by more in government data series) while income grew by only 24% and rents by 31%. But with prices having already come down, home prices are up now by 45% from 1998 (and by 67% according to Case-Shiller and OFHEO price indices) while income grew by 34% and rents by 41%. Though price growth is still higher than income growth over the past 10 years, mortgage rates are lower today, which makes affordability conditions today essentially equal to those in 1998, when no one would have claimed a housing market bubble or the need for some price correction.
As I stated, the economy is getting hit from falling home values. Lower prices and the associated loss of housing wealth are prohibiting consumers from spending. Lower prices and the associated loss in mortgage backed security valuations are leading to a multiplier contraction in loan availability in all areas, from credit card to small business loans. Prices have fallen back to fundamentally justifiable levels and we have to stop the economy from hemorrhaging further.
Given that President-elect Obama is talking about a $500 to $700 billion stimulus package, and the existing $350 billion in the second tranche of TARP funds, the focus to meet housing demand is a very modest cost of less than $100 billion to help the housing market and the economy recover.
As to the economy, it is contracting hard and fast in the current fourth quarter. The GDP is expected to fall by a whopping 5.2 percent. The momentum suggests that it will contract throughout the first half of 2009. The unemployment rate could top out at 8.3 percent towards the end of next year from the current 6.7 percent.
Therefore, it is imperative to get the stimulus plan in place and it must include a focus on getting the buyers back into the market. Many buyers are rational and will wait for further price drops. But putting money on the table now - through vehicles such as a home buyer tax credit (without the repayment feature) and reduced mortgage rates - will easily offset that buyer pessimism. Now that the rumor is out on a possible 4.5% mortgage rate, some serious buyers are hesitating about signing buyer contracts. Why buy now if rates will be lower later? The government needs to act fast about this rumor: either implement it quickly or squash it. The good news on the rumor is that fence sitters are beginning to do some home searches, which in turn will fill the pipeline with a large set of potential buyers for the upcoming spring buying season. For those consumers already in the serious stages of home buying, talk to your lender about locking in the low mortgage rates today (at around 5.5%) for 60 days and then have a clause included to have the ability to trade-down to a lower rate (say, 4.5%) once the government decides to implement the housing stimulus package.
The economy and the financial market are in deep trouble. The problems will be greatly mitigated by a focus on the housing market. A housing market recovery is a sure guarantee for an economic recovery.
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >
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