Existing Home Sales Rise - Analyst Blog

In December, existing home sales ran at a seasonally adjusted annual rate of 5.28 million. That pace is 12.3% higher than in November, but 2.9% below the year-ago rate. The year-ago rate of 5.44 million was inflated as everyone was rushing to get the deals done before they thought the first-time buyer tax credit would expire. The tax credit was unexpectedly extended (and expanded) at the last minute.

Thus, take the year-over-year decline with a grain of salt. The December sales rate was well above consensus expectations of a 4.80 million annual rate. The spike a year ago due to the tax credit -- along with the secondary spike when the credit actually did expire for real in June -- can be seen in the first graph (from http://www.calculatedriskblog.com/)

Sales of single-family homes rose by 11.8% on the month to a rate of 4.64 million, and are off 2.5% year over year. The median price of a single-family home nationwide slipped 0.2% from a year ago to $169,300. Condo and co-op sales rose 16.4% on the month, but are down 5.2% year over year. The median condo price slumped 7.4% from a year ago to $165,000.

Regionally, sales were up on the month in all four Census regions, ranging from a 16.7% jump in the West, to a 10.1% rise in the South. On the other hand, all four regions were down year over year. The declines ranged from 5.4% in the Northeast to a 1.5% drop in the West.  Median prices fell from a year ago in the Northeast (-1.4%) and the West (-5.6%) were unchanged in the South and rose by 3.5% in the Midwest.

Existing Home Sales vs. New Home Sales

The level of activity in used home sales really is not that important in isolation. It is just the transfer of an existing asset, and does not add a lot to economic growth. The one exception to that is realtors' commissions.

Indirectly, it can help as people will often remodel and redecorate a “new for them” house. That can stimulate some sales for paint companies like Sherwin Williams (SHW) and perhaps it is good for furniture firms like La-Z-Boy (LZB), but it pales compared to the economic activity generated by a new home sale.

New homes not only need new paint on the walls, but they need the walls. That means lots of business for wallboard firms like USG (USG), timber firms like Weyerhaeuser (WY) and roofing and insulation firms like the Johns Manville division of Berkshire Hathaway (BRK.B). It also means that those firms have to hire more workers, so the employment effect of new home sales goes well beyond the roofers and carpenters actually on the jobsite.

Where used home sales are important is in relation to the inventory of houses for sale. That will influence the future direction of hosing prices. Used home prices are extremely important. As used home prices fall, more and more people find themselves underwater on their mortgages. As long as a homeowner has positive equity in their house, the foreclosure rate should be zero.

After all, it is better to simply sell the house and get something for it rather than simply let the bank take it and get nothing for it. The more people under water, and the deeper they are, the higher foreclosures and strategic defaults are going to be.

A strategic default is when someone has the cash flow available to continue to make his mortgage payment, but simply decides not to, since paying is a just plain stupid thing to do from a financial perspective. If you have a house that could only sell for $150,000 in the current environment, and you owe $200,000 on the mortgage, in effect you have the option of “selling” the house to the bank for $200,000 simply by stopping writing the checks.

Of course that will be a hit to your credit rating, but $50,000 is probably worth a bit of a tarnish on your Fico score. If the difference is only $5000, then the hit to your credit score makes less sense, and there are lots of non-economic factors (a house is after all a home, not just an investment) that come into play.

Housing Inventories

In December, inventories fell by 4.2% to 3.56 million, but remain well above the year-ago level. That puts the months of supply at 8.1 months, down from 9.5 months in November. While moving in the right direction, it is still a pretty high number. A “normal” months of supply is about 6 months, and during the housing bubble 4 months was the norm.

Also, the inventory numbers are not seasonally adjusted, even thought here is a seasonal pattern when they tend to decline over the holidays. The second graph (also from http://www.calculatedriskblog.com/) traces the months of supply and the year-over-year change in inventories. The sharp drop in the months supply over the last few months is encouraging, but the level still suggests downward pressure on existing home prices over the next few months.

Fortunately, relative to incomes and rents, home prices are not as absurdly overvalued as they were then, so the magnitude of the coming price declines is likely to be a lot less over the next year than the 30% plunge in 2008 and early 2009. I suspect they will fall by about 5% from here.

Still, that could do a lot of damage, since the equity cushions are a lot smaller now than they were in 2007 or early 2008. Now 23% of all homes with mortgages are underwater, and another 5% have less than 5% positive equity. If housing prices fall more than 5%, then all of them will also be underwater, and lots of homes that are only slightly underwater (where non financial considerations tend to dominate) will become deeply underwater.

Foreclosures Falling - A Temporary Condition?

Foreclosures have slowed recently, but that is only because of the fraudclosure scandal, where the banks have proved to be exceptionally incompetent in handling the paperwork related to securitized mortgages. Basically, they can't really prove that they hold the mortgage, and thus don't have the right to foreclose. It remains to be seen just how big a problem that will prove to be. If could just be a technical glitch that will gum up the works for a few months, or it could be a HUGE problem that once again undermines the solvency of the entire banking system.

This is a very good reason to avoid bank stocks, especially those like Bank of America (BAC) and Wells Fargo (WFC) where mortgages make up a big part of their business. What is clear is that what they were doing was illegal and at least technically constituted fraud and misrepresentation to the courts. There should be more than a handful of bankers who end up with long terms in prison as a result (although just because there should does not mean that there will be).

However, with falling home prices it is likely that the pace of foreclosures will pick up again. Most of those that are being foreclosed on have indeed fallen far behind in their mortgage payments, and so in that sense the foreclosures are legitimate, even if the paperwork is a mess. The combination of underwater homes and reduced cash flow from one or both of the breadwinners in a family being out of work is a toxic mixture for the health of not just the housing market, but the economy as a whole.

In Summation

In absolute terms, this was a pretty solid report, and it was better than expectations. Still, the huge glut of existing homes on the market -- and the shadow inventory of homes that are likely to be foreclosed upon and thus come to market in the near future -- means that we really have very little need to build new homes. Thus residential investment, the historical prime locomotive in pulling the economy out of recessions, will stay derailed.

The jobs not created by a rebound in housing construction will mean that household formation will stay depressed, thus further depressing the demand for housing. To put that in more concrete terms, young adults will not be able to get a job and form a family; instead, they will continue living in Mom and Dad's basement, rather than soak up the existing housing inventory. A nasty "chicken and the egg" situation.

 
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