FACTS & TRENDS: U.S. HOUSING TO STAY COLD

The following WSJ piece summarizes the recent state of the U.S. housing market as per the conventional wisdom:

Home Sales Hit 18-Month Low Home sales fell in January to their lowest level in 18 months as higher prices and mortgage rates squeezed buyers who continue to face shortages of properties for sale.

Sales of previously owned homes fell by 5.1% to a seasonally adjusted annual rate of 4.62 million, the National Association of Realtors said Friday. The median sales price in January stood at $188,900, up 10.7% from a year earlier.

Sales volumes are being challenged by reduced affordability of homes and severe winter weather in many parts of the country—two factors putting a damper on demand. But real-estate agents say the market also is being constrained by a lack of supply. There were only 1.9 million homes on the market in January, according to the Realtors’ group. While that was a 2.2% increase from December, only three months during the past 12 years have seen inventories at even lower levels. (…)

Construction of new homes also remains near its lowest level in 50 years. Builders completed fewer than 570,000 new single-family homes last year, down from an average of 1.1 million from 1990 through 2003. (…)

Let’s deal with the weather effect first.

It’s easy to blame softer buyer demand on frigid January temperatures, but weather seems to have discouraged home sellers, not buyers. During January, the polar vortex brought multiple blasts of cold air from the Arctic to large segments of the U.S. east of the Rockies. Six Redfin markets on the East Coast, Boston, Philadelphia, Chicago, Washington, D.C., Long Island and Baltimore, endured temperatures more than 10 degrees below-average for a total of 12 to 24 days that month. In “vortexed” markets, new listings during January fell 12.7 percent from the year before compared to 4.3 percent growth in non-”vortexed” markets.

In contrast, buyer demand remained the strongest in the coldest markets during January. In markets that got “vortexed,” 13 percent more Redfin customers made offers on homes than last year. In markets that didn’t, growth was only 4 percent.

Redfin’s story does not explain why 2 of the 6 “vortexed” markets nonetheless saw flat to up listings.

It is a chicken-and-egg situation:

According to Redfin Denver agent Paul Stone, “I have several sellers whose homes are ready to be listed, but they won’t pull the trigger until they find something to buy. Their biggest fear is that they will be left ‘homeless’ if they sell too quickly, forcing them to move in with in-laws or find an expensive short-term sublease.”

Looking at the housing market with the wrong lens can lead to misleading conclusions. When we look at longer term charts and we consider the 2004-2007 period as a cyclical anomaly unlikely to be repeated anytime soon, the current sales stats don’t seem so tepid. Similarly, the jump in inventory after the beginning of the crisis was a necessary consequence of the previous excesses which needed to be cleared through “forced” divestitures. While current inventory is indeed low, it is not as depressed as many shorter term charts like the WSJ chart at the top suggest. (First chart below from CalculatedRisk)

The other thing is that housing stats are generally presented nationally. Yet, housing is an inherently local market. Given that the housing crisis was so much more acute in certain states like California, Nevada, Arizona and Florida, we are still dealing with the important distortions that these states have on the national averages, one way or the other.

Not quite the same situation on housing starts, however. The current cyclical low is really low, and yet, it is still sputtering…

Why should anybody be surprised here? First-time buyers, which generally account for 40% of new houses, fell to 30% last year and 27% in December. Don’t we all know that:

• employment growth remains slow;
• youth unemployment is very high;
• the middle class is squeezed out;
• income growth is inexistent for 99% of the population;
• new house prices are up 70% from 2000;
• lending standards remain tight, even more so for young families;
• household formation is slow.

First-time buyers are now only 27% of the market and are concentrated in the higher end segment which explains in large part the 25% statistical jump in the median new house price since 2012. January sales of homes priced above $500,000 (10% of the market) increased 19.8% YoY, while sales of homes under $250,000 (65% of the market) declined 10.7% YoY. Distressed sales were 15% of total sales in January, down from 24% last year. Since foreclosures and short sales sold on average around 15% below market value, their declining share of the total tends to the boost median price.

Forget the harsh winter, here is the crude math that’s really freezing buyers out: combining the rise in 30 yr mortgage rates from 3.53% in February 2013 to 4.28% currently with a 14% increase in house prices results in a 25% increase in monthly mortgage payments. This cold cash reality makes it difficult to expect the new housing market to really take off any time soon.

The reality for “ordinary folks” is that you may “yes-we-can!” all you want, things just don’t happen magically. Two charts illustrating some of the causes for the big freeze (left chart from Minack Advisors, right chart from Scott Grannis):   

For virtually every working American, the “lost decade” has been a decade of significant lost buying power. For the majority of Americans, there is little hope for quick restoration since middle-wage work has been replaced by low-wage jobs.

Meanwhile, new and existing house prices are rising which, it is hoped, will help increase supply which, in turn would presumably stimulate demand. Again, be careful of using the right lens. This next chart from Core Logic illustrates the dichotomy:

Although affordability can vary substantially by market, it also varies dramatically depending on whether you are already a homeowner or not. Consider the fact that affordability is a concept intended to measure a buyer’s ability to purchase a home given the prevailing interest rate and his or her income. An increase in the price of housing is captured by the homeowner as equity. The equity then can be moved to the next house being purchased, so an existing homeowner’s affordability level is unchanged by changing home prices. First-time homebuyers, on the contrary, aren’t so lucky.

By the way, we should also revisit the meaning of “new” homebuyer given that home ownership has declined from 69% in 2005 to just above 65%.

In effect, affordability for first homebuyers is back to its early 2009 levels, before the Fed began to engineer mortgage rates down. Tapering won’t do much to help in this regard.

But rejoyce, spring is almost there! Well, here’s the picture from Redfin:

Across 18 markets in January, there were 2.9 percent fewer new agent-listed properties than the year before. So far in February, new listings have fallen even more.

Redfin agents say new listings are coming this spring, they just aren’t coming early. “Home sellers are in no rush this year. They feel confident that their home will sell easily and at a higher price between March and May, so they see little incentive to list before then,” according to Redfin Northern Virginia agent Jeremy Cunningham.

At the same time, demand for real estate photography services, a potential leading indicator of new listings, is strong, says Brian Balduf, CEO of national firm VHT Studios. According to Brian, “Early demand feels like a tsunami warning. In January, our business was up 15 percent compared to last year. We are rapidly ramping up in all markets because we are anticipating a huge spring for new listings.”

Most housing optimists see the recovery coming from the supply side. CalculatedRisk summarizes the bright outlook:

Also higher prices should lead to more inventory (the NAR reported inventory was up 7.6% year-over-year in January). More inventory should mean slower price increases (maybe even flat of declining prices in certain markets), and also more non-distressed sales. (…) As Lawler recently wrote:

First, fueled by low mortgage rates, low new and existing home inventories, and some “pent-up” demand, builders as a group experienced a significant increase in net home orders starting in the latter part of 2012 and continuing into the spring of 2013. While many builders responded by increasing significantly land acquisitions and development spending in 2012 and 2013, many builders were unable to meet demand, partly reflecting longer-than-normal development timelines related to “supply-chain” issues. Many responded by increasing prices substantially, in some areas at a pace seldom seen. When mortgage rates subsequently rose sharply, the combination of higher mortgage rates and substantially higher new home prices resulted in a significant slowdown in net home orders. While mortgage rates eased somewhat in the latter part of last year, orders did not rebound much (or for some builders at all), mainly reflecting potential buyers balking at the higher home prices.

That slowdown did not dampen most builders’ optimism for the 2014 spring selling season, and most builders have the land/lots to increase substantially their community counts this year, and plan to do so. One reason for their optimism is that the previous hikes in prices have at many builders pushed margins up well above “normal” levels, meaning they can drive higher revenues with higher volumes without price increases, and in fact can be “quite profitable” by holding prices even if construction costs rise. As such, a reasonable assumption for new home prices from the end of 2013 to the end of 2014 would be “flattish.”

The bottom line is the housing weakness should be temporary. There should be more inventory this year, price increases should slow, and sales volumes increase.

So, higher prices for existing houses will stimulate supply which should slow or even decrease prices. Meanwhile, builders will hold new home prices at their “abnormally” high levels which should “drive higher revenues with higher volumes”.

I am really getting old!

My own sense is that if there is really a tsunami of sellers coming, prices will decline because there are no signs of buyers anxiously waiting to pounce here (chart from Lance Roberts). If prices decline, what will happen to supply and the chicken-and-egg problem?

Anyway, something must happen to restore true affordability. Since Fed tapering will likely prevent mortgage rates from declining much…you see the picture.

Absent lower prices and/or lower rates, what is needed now are tax credits for lower to mid-income new homebuyers. This would stimulate demand for houses for “normal folks” and incite builders to also invest in that segment which, in turn, would stimulate construction. Builders should also rethink their margins strategies. It is in their best long term interest to get “first time buyers” on board.

In the meantime, I am not holding my breadth for housing to pull the economy.