In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Sunday, February 23, 2014

Housing Weakness: Temporary or Enduring?

by Calculated Risk on 2/23/2014 12:29:00 PM

The recent data for housing has been weak, with new home sales and housing starts mostly moving sideways over the last year (with plenty of ups and downs, and I expect downward revisions to Q4 new home sales). Existing home sales have declined 14% from a peak of 5.38 million in July 2013 on a seasonally adjusted annual rate basis (SAAR), to just 4.62 million SAAR in January.

There are several reasons for the recent weakness:
1) Higher prices. Case-Shiller reported prices were up 13.7% year-over-year in November. Other indexes had smaller increases, but all showed significant price increases in 2013.

2) Higher mortgage rates. 30 year fixed mortgage rates increased last summer from around 3.5% in May 2013 to 4.4% in July 2013. Since then, mortgage rates have mostly moved sideways, but some of the weakness since last summer is probably related to higher mortgage rates.

3) Fewer distressed sales.   Although the decline in foreclosures, short sales, and mortgage delinquencies is good news, this has meant fewer overall existing home sales (this isn't a surprise - I've been predicting a decline in overall existing home sales for exactly this reason).  Even though overall sales have been declining, equity sales (aka conventional transactions), are actually up year-over-year.  Note: Of course fewer distressed sales should be a positive for new home sales, so this doesn't explain some of the recent weakness for new home sales.

4) Less investor buying.  This is related to fewer distressed sales.  If we use cash buyers as an indicator of the level of investor buying, then the decline in cash buyers in areas like Las Vegas, Phoenix, and Sacramento suggests investors are pulling back.

5) Limited inventory.  The sharp decline in inventory over the last few years was a key story for housing (I beat that horse into the ground).   There are several reasons inventory has been low: a) Most of the recent investor buying has been "buy-to-rent" and these investors aren't selling, Note: Economist Tom Lawler discussed this two year ago, and he concluded that a significant "share of the decline in the share of homes for sale reflects the acquisition of SF (and condo) properties by investors as multi-year rental properties", b) Is it difficult for people who are underwater (negative equity)  to sell,  c) Seller psychology: When the expectation is that prices will fall further, marginal sellers will try to sell their homes immediately. And marginal buyers will decide to wait for a lower price. This leads to more inventory on the market. But when the expectation is that prices are stabilizing (the current situation), sellers will wait until it is convenient to sell. d) Low inventory can keep some potential sellers from listing their homes because they can't find a move-up home to buy.

6) Supply chain constraints for New Homes.   I noted at the beginning of 2013 "I've heard some builders might be land constrained in 2013 (not enough finished lots in the pipeline)." That was correct - some builders had limited entitled land and there were other constraints too (material shortages, skilled labor in certain areas) - and this limited the number of new home sales last year (sales were only up 16.3% in 2013).

7) And some of the recent weakness in December and January (and February) might have been weather related.

Here are a few graphs to show the recent weakness:

Total Housing Starts and Single Family Housing StartsClick on graph for larger image.

Total housing starts in January were at a seasonally adjusted annual rate of 880,000 - only 2% above January 2013, and single-family housing starts in January were at a rate of 573,000 - down 6% from January 2013.

Although starts have been up and down over the last year, starts have mostly moved sideways. Of course starts were up 18.7% in 2013 compared to 2012, so there was little "weakness" on an annual basis.

New Home SalesNew home sales followed the same pattern has housing starts: up solidly in 2013 compared to 2012, but with sales mostly moving sideways all year (with ups and downs).

New Home Sales in December were at a seasonally adjusted annual rate (SAAR) of 414 thousand up only 4.5% from December 2012.

New home sales for January 2014 will be released this coming Wednesday, and I expect sales to be down year-over-year, and to see some downward revisions for Q4 sales.

Existing Home SalesExisting home sales in January were at a 4.62 million SAAR, and were 5.1% below the January 2013 rate.

So what should we make of this "weakness"?

First, the decline in existing home sales is not bad news. See: Home Sales Reports: What Matters. Fewer distressed sales - and more equity sales (conventional sales) - is a positive.

Second, we need to put the recent "weakness" for starts and new home sales in perspective.   New home sales were up 16.3% in 2013 - a solid year of growth - and 2013 was still the sixth weakest year since 1963 when the Census Bureau started tracking new home sales.  For housing starts, even after increasing 28.2% in 2012 and 18.7% in 2013, the 927 thousand housing starts in 2013 were the sixth lowest on an annual basis since the Census Bureau started tracking starts in 1959 (the three lowest years were 2008 through 2012). Also, this was the fifth lowest year for single family starts since 1959 (only 2009 through 2012 were lower).

These low levels of housing starts and new home sales, combined with a growing population and new household formation, suggests new home sales and housing starts should increase over the next few years.

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.  For new homes, the builders are reporting more selling communities in 2014, and it appears some of the land constraints have diminished. 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.