Existing Home Sales rebounded by 7.6% in August from an absolutely dismal showing in July. The seasonally adjusted annual rate was 4.13 million up from 3.84 million in July, but down 19.0% from a year ago when the rate was 5.10 million.
The August rate was just slightly better than the consensus expectations of a 4.10 million annual rate. The rate was well below the June rate of 5.26 million, which was boosted by people trying to close on their homes by the end of June so they could qualify for the homebuyer tax credit. That pulled sales into June from July, and we are still suffering the hangover from the tax credit party, just not quite as bad as in July. Sort of like we have one cup of coffee in us, but still feel like we got run over by a beer delivery truck.
The graph below (from http://www.calculatedriskblog.com/) shows the path of existing home sales since 1994. After rising sharply as the housing bubble inflated, they fell from mid-2005 to the start of 2009. They spiked with the first homebuyer tax credit, which everyone thought would expire at the end of November. It was unexpected extended at the last minute and actually expanded so that people could agree on buying by the end of April and close by the end of June (sales are recorded at closing).
Note that even though the second round was more generous than the first round, it packed much less of a punch. After it expired for good, sales plummeted in July and the August rebound looks feeble by comparison.
Sales of single family homes rose by 7.4% on the month to 3.62 million but are 19.2% below the year ago rate of 4.48 million. We are also 21.6% below the June rate of 4.62 million. Sales of condos rebounded by 8.5% to an annual rate of 510,000 in August but are 17.1% below the year-ago rate of 615,000 and 20.3% below the tax credit inflated rate of 640,000 in June.
Regionally, sales in the Northeast rose by 7.8% on the month but are down 24.4% from a year ago. Sales in the Midwest rose 5.0% for the month but remain 26.3% below last year’s level. In the South, the largest and most important region, sales rose 5.2% for the month and are down 13.4% year over year. The West was the best this month with an increase of 13.8%, but still 16.1% below a year ago.
Total inventories fell by 0.6% to 3.98 million. That combined with the higher sales rate helped push the months of supply metric down to a still very high 11.6 months from a record 12.5 months in July. The graph below (also from http://www.calculatedriskblog.com/) shows the long-term history of the months of supply metric.
Think of it as a inventory to sales measure. If there are lots and lots of homes on the market relative to how fast homes are selling, there is going to be downward pressure on housing prices. During the housing bubble, the months of supply usually had a “four handle” on it, and existing home prices were soaring.
The rise in the months of supply numbers during 2006 were the loudest warning that the housing bubble was about to burst. The double-digit months of supply during 2008 were associated with the biggest declines in housing prices.
Housing prices stabilized and started to creep upwards in late 2009 as the months of supply improved. The tax credit was largely responsible for this. Not only did it raise the sales rate (hence lowering the months of supply), it was also a direct third party subsidy for a transaction to take place. When that happens, economic theory tells us that the benefit will be split between the buyer and the seller. The buyer benefits when he files his taxes, the seller gets a higher selling price.
The next two graphs take a closer look at the relationship between the months of supply and median home prices, and also break out single family homes from condos. Note that the months of supply have been higher for condos than for single family homes on a consistent basis.
In August, the rate for single family homes fell to 11.3 months from 11.9 months, and is up from 9.0 months a year ago. The initial tax cut boost cut the single family months of supply to just 6.2 months, which is right about at a “normal level.” The condo months of supply are at 13.9 months, down from an astronomical 17.3 months in July, but still up from 12.1 months a year ago. They hit an interim low of 8.0 months in November 2009.
The still-very-high level of inventories of existing condos relative to sales opens up very big questions about the sustainability of the surge in housing starts for multi-family structures that we have seen over the last two months (see “Housing Starts Surge”).
The median price of a home was $178,600 in August. That is down 1.9% from July but still up 0.8% from a year ago. With the months of supply still in the double digits — and higher than they were during the heart of the 2008 housing bust — it seems very clear to me that the price of existing homes will continue to fall over the next six months to a year.
Fortunately, relative to incomes and rents, existing homes are far more reasonably priced than they were in 2007 or 2008. They are not cheap by historical standards, but not wildly high as they used to be. That fact will probably limit the coming decline to between 5 and 10% as measured by the Case Schiller index, not a repeat of the earlier decline of over 30%.
Why am I spilling so much ink (or electrons) over the months of supply? Because it is the biggest factor in the future direction of existing home prices. It is existing home prices that are important to the economy, not the level of turnover. The sale of an existing asset, like a used home, creates almost no economic activity.
Oh sure, it is very important to the income of realtors, and when people move in to a “new for them” house they tend to redecorate. That is great for paint firms like PPG Industries (PPG), retailers like Home Depot (HD) that sell the paint and perhaps for furniture stores like Ethan Allen (ETH), but it pales to the amount of activity that takes place when a new home is built and sold. New homes also need paint, but they also need lumber, wall board, roofing materials and especially labor. Turnover of existing homes does nothing in that regard.
Used home prices are a different story altogether. For the vast majority of Americans, equity in their houses is their most important asset and store of wealth. Or at least before the housing bubble popped and erased over $8 trillion in housing wealth it was. As it stands now, 23% of all homes with mortgages (about 70% of all homes, the rest are owned free and clear) are “underwater” and an additional 5% have less than 5% positive equity. Thus if home prices do decline another 5%, they too will own more on their houses than the house is worth.
Being underwater on a house is a necessary but not sufficient condition for a foreclosure to happen. After all, regardless of how bad your cash flow situation is — from being laid off to medical problems to divorce, etc. — if the house is worth more than the mortgage, you are always better off selling rather than simply letting the bank take it.
There are lots of people who are underwater but are still making their mortgage payments, and who plan to continue doing so. After all, a house is not just a financial asset, it is the home that you are living in. There are many non-economic considerations that are more important to people. For example, not having to pull kids out of a school that they like, or the little marks made on the wall at each birthday showing how the kids have grown.
There is a limit to just how much those non-economic factors are worth. Few would simply walk away if the house was worth just $1,000 less than the mortgage, particularly if they are still employed and have the cash flow to continue to make the payments. On the other hand, if the house is worth $100,000 less than the mortgage, and one or both of the parents lose their jobs, well little Suzie will just have to cope at a different high school.
The more home prices fall, the more people there are who are underwater, and the deeper under people are. Being underwater AND being unemployed makes things doubly difficult. In the past, people might move from, say, Nevada with a sky-high unemployment rate, and move to Nebraska, with a relatively low unemployment rate. However, if you have to write a $50,000 check to sell your house in Nevada to take a $75,000 a year job in Nebraska, that job offer might just as well not exist.
The decline in home prices is thus turning some of the cyclical unemployment into structural unemployment. It is also fraying the labor mobility that had been one of the great strengths of the American economy relative to say Europe.
In Summation
While this report was largely as expected, it is still bad news. The months of supply are going to continue to push prices down, and as they do, exacerbate the foreclosure crisis. The weak sales come despite mortgage rates that continue to fall to the lowest levels in a generation. If people could refinance their mortgages at these low rates, that would be a very important stimulus to the economy by putting hundreds of dollars a month into each consumer’s pocket.
However, if you are underwater, or just have a little bit of positive equity, that option is not open to you. Banks were burned badly by having very high loan to value ratios in the bubble, and want to see a lot more equity in houses, not less. Underwater houses simply cannot be refinanced.
Furthermore, lowering the interest rate and thus the monthly payment might help, but it does not solve the core problem. Yes, it is better to be paying 4.5% on your mortgage than 6.5% — it is much more affordable. But if the mortgage is still for $200,000 and the house is only worth $150,000, does it really make sense to continue to pay the mortgage, even at the lower rate? The focus the banks have had on lowering mortgage rates, rather than reduction in the principal amount of the loan in trying to modify mortgages, is the key reason why the HAMP program has been a notable failure.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
