The Residential Housing Market Continues to Struggle

Last week brought a slew of more bad news regarding the residential housing market. There were substantial declines in sales volume of both new (just built) and previously occupied (existing) homes for the month of February. Additionally, one major and closely followed home price index (where price data lag the market by two months) exhibited a 3.1% decline in January, marking the fourth consecutive month of price declines for this index. In most regional markets, the situation remains deflationary as prices continue to slip and (as is characteristic of deflationary markets) demand declines as buyers await further price declines before jumping in.

While many have criticized the U.S. Federal Reserve’s (the Fed’s) continuation of quantitative easing when other indicators of economic activity have improved dramatically over the past year, continued downward trends for both the demand and pricing in the residential housing market—still a substantial source of personal net worth for many Americans—seems to justify the Fed’s continued efforts to inject liquidity into the overall economy, despite the longer-term and broader inflationary risks this policy could engender.

Existing Home Sales Decline 9.6%

On March 21, the National Association of Realtors (NAR) reported that sales of existing homes dropped 9.6% for February versus January to 4.9 million units on a seasonally adjusted annual rate basis (or SAAR). In addition to the magnitude of the one-month decline, the other telling statistic was that nearly 40% of home sales in February were either foreclosure sales by financial institutions or “short sales” where the seller accepts a price that is less than what they owe on their mortgage. The national median sales price fell 5.2% to $156,100, which was the lowest median price recorded by the NAR since April 2002.

The one bright spot in the report was that metropolitan markets which had experienced the sharpest price declines over the past three years have seen a commensurate increase in sales volume. Miami, for example, saw the largest price increases during the housing bubble (and subsequent declines) and had a 46.4% increase in sales volume on a year-over-year basis for February. Meanwhile, prices declined 18.6% on the same year-over-year basis—something more typical for the law of supply and demand in a normally functioning market. (A year-over-year price change compares the increase or decrease in price for any calendar month versus the same price one year earlier.)

New Home Sales Decline 16.9%

On March 23, the U.S. Department of Commerce reported that newly built home sales plunged 16.9% in February to just 250,000 homes (on a SAAR basis), which was the third straight monthly decline and the lowest level of sales volume on record dating back nearly half a century. The median price of new homes also declined 14% to $202,100, the lowest since December 2003.

Last year marked the fifth consecutive year of sales volume declines in new homes, which had reached a peak at the height of the housing bubble in 2005. And not surprisingly, home builders have responded by curtailing new home building. New building permits in February—a reliable indicator of future construction—have declined to their lowest level in 50 years. According to some market observers, the continued pricing declines and rising inventories of existing homes for sale are taking the wind out of the demand for new home construction—which, ironically, is an important employer—at a time when lower unemployment could ease pressures on both existing and new home markets.

The chart below illustrates the rise and subsequent decline in sales volume for both existing and new homes from January 1999 to February of this year. The decline has been most dramatic with new home sales, which peaked in mid-2005 at nearly 1.4 million units on a SAAR basis. Last month, that same figure was only 250,000 units. Existing home sales have been less volatile on a relative basis but still highly affected by the bursting of the housing bubble, the Great Recession, and the aftermath of both these events. Home sales have declined from approximately 7.1 million units to 4.9 million units last month on a SAAR basis. The chart also highlights the impact of the home buyer tax credit implemented by the Obama administration in 2009. The program had two deadlines—the original date of November 2009 and the second in June 2010, when the program was extended. At both these times, existing home sales briefly recovered (as highlighted by the dashed oval on the chart) only to slump again upon their expiration.

 

Foreclosures and Home Price Pressures

One factor that has weighed on both existing and new home prices is the efforts of banks and other financial institutions holding non-performing mortgages to clean up their balance sheets. When banks foreclose on a residential home, they tend to be eager and quick sellers of the property, attempting to quickly clear the loan from their books and obtain whatever cash they can to offset their loss. They certainly want to maximize whatever price they can receive, but as a general rule, expediency tends to outweigh holding out for a better price. And with approximately 3 million new foreclosures expected to be processed just this year (or about 60% of the seasonally adjusted annual rate for existing home sales in February of 4.9 million units), this creates a huge downward draft on pricing for both existing and new homes.

The chart below plots the year-over-year change in home sale prices on a monthly basis from December 2000 to December 2010 using the S&P/Case-Shiller Home Price Index for the largest 20 metropolitan markets in the U.S. ^, It also plots the residential mortgage delinquency rate (i.e., mortgages at least 60 days overdue on payments) as a percent of all residential mortgages outstanding over the same time frame.

The effects of the housing bubble through the first half of the last decade can be seen as year-over-year increases in the S&P/Case-Shiller 20 Home Price Index averaged about 12.5% until 2004 when they spiked to nearly 17%. During this time frame, the mortgage delinquency rate ranged between 4-5%. And as the housing price bubble collapsed between mid-2005 and its bottom in November 2008, mortgage delinquency rates jumped from 4% to a peak of 10.1% in March of last year—an inverse but understandable relationship as prices collapsed, unemployment rose, and mortgage holders became increasingly stressed financially.

But more recently (since March of last year), and as highlighted by the dashed oval in the chart below, we’ve seen home prices and mortgage delinquency rates both decline in tandem. One explanation for this is what we noted earlier—banks moving aggressively to process non-performing (or delinquent) mortgages through the foreclosure process, which reduces the delinquency rate but places downward pressure on selling prices.

 

What’s Needed: Job Growth and Increased Consumer Confidence

Despite the pain this large foreclosure process is creating for home prices, many economists and policy makers argue that the U.S. housing market will never fully recover until prices reach a bottom, financial institutions become able (and willing) to resume lending to consumers, and households are again confident that home ownership is a smart long-term investment for their future. Record low mortgage interest rates (for those who could qualify) have not accomplished this goal, nor have one-time tax credit schemes implemented by the government (as mentioned previously).

The longer-term and more elusive solution is job growth and reduced unemployment, which lead to increased consumer confidence. And consumer confidence—about their economic situation and outlook—is probably the most important determinant of when and why people take out a long-term debt obligation like a home mortgage and buy what most still consider the American Dream: home ownership. Moreover, there is a relationship between consumer confidence and the employment market. To illustrate this, the chart below plots the monthly Conference Board Consumer Confidence Index from January 2000 through last month (February 2011), and the monthly change in nonfarm payrolls over the same time frame. The long-term average for the Consumer Confidence Index is in a range of 85-115, with levels above this suggestive of euphoria and levels below this of pessimism. (Note: On March 29, the Conference Board announced the Consumer Confidence Index had declined to 63.2 for the month of March.)     

 

Over the past 11 years, U.S. consumer confidence has shifted from clear euphoria (in 2000, due largely to the strong economy of the late 1990s and its job creation) to a brief spell of pessimism with the recession of 2002, to an extended period of average confidence (despite the growing housing bubble) from 2004 to 2007, to an extended period of pessimism since early 2008. While the overlay of consumer confidence and monthly changes in nonfarm payrolls over these 11 years is hardly scientific, one can see a relationship between large changes in both. And presuming this relationship is correct, an important factor that will help us recover from our current residential housing woes is substantial reductions in unemployment and a subsequent recovery in consumer confidence.

 

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The S&P/Case-Shiller 20 Home Price Index tracks changes in the value of residential real estate in 20 metropolitan regions of the U.S. The indices are calculated monthly and published with a two month lag. This index is produced by Standard & Poor’s.

The chart does not show the 3.1% decline in the index for January 2011.

 

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www.americancentury.com

 

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