The glass half-full housing recovery
Is it wiser to view a depressed market that’s improving as weak or recovering?
Since early 2012 when housing prices stopped going down, I characterized the price rally as a reflation of the old housing bubble rather than a price recovery. IMO, the crash was the price recovery because the prices that preceded it were a bubble with no tether to fundamental values. The price crash restored market prices to values supportable by income and rent.
However, most people don’t want to see this reality, particularly deeply underwater homeowners. Most want to believe peak housing bubble prices were fair value and the crash represented a deeply undervalued condition that needed to recover back to fair value prices. This viewpoint requires people to believe that record low interest rates and a bevy of market manipulations were needed to restore fair value rather than restore artificially high bubble-era prices.
A durable housing recovery based on improving fundamentals would be hard to deny, and it wouldn’t need so many artificial boosts. A real recovery would be characterized by resurging new home construction and steady gains in sales and prices commensurate with strong job growth and rising incomes. Although these conditions are improving, by most measures the economy and the housing market are still weak.
Unfortunately, seeing the glass as half full with regards to investments a path to ruin. Historically, taking a glib and Pollyanna view toward major investments is characteristic of herd behavior in a financial mania. People need to make important decisions about housing with their eyes open to the potential disasters, not just to the potential rewards.
This is a basic philosophical difference I have with most financial writers who view their work as investor therapy, a source of reassurance for decisions already made. People who bought houses want to read the housing market is going up and prices will head to the moon, so that’s what financial reporters tell them — except for Barry Ritholtz. He prefers reality from what I can tell.
By Barry Ritholtz, 24 Aug 27, 2015
We interrupt this crash and recovery for a brief word about the economy, in particular residential real estate and new home sales. This is an area of the economy I have been studying and writing about for decades.
New home sales were reported earlier this week; they are a component of gross domestic product (existing home sales are not). We learned this morning that second quarter GDP was revised to 3.7 percent. So new home sales are especially important, even though they make up less than 15 percent of total housing sales.
A few things you should know about this data: Month-to-month, it is a very noisy series. It is self-reported by builders, and I always have gotten the sense that they get around to doing the paperwork…eventually. Quarterly figures are more or less accurate, but each month comes with a high double-digit probability of statistical error.
I want to draw your attention to two of my favorite charts, courtesy of Bill McBride of Calculated Risk. He uses data in a way that is most informative.
The relative scale of the housing market’s poor performance is readily inferred from the chart above. Those tall bars represent sales during the final stages of the housing bubble (which were above normal), and the short bars at the bottom show the dismal performance since 2008.
The chart above is new home sales, presented as a monthly series on an annual non-seasonally adjusted basis. Each colored bar represents a different year. Looking at new home sales this way allows us to easily see the “Seasonal Homes Sales Trend.” Home buying occurs on a very specific annual cycle, rising in the spring, peaking in the summer (got to get the kids enrolled in the new district before school starts) then tailing off in the winter.
By omitting the seasonal adjustments, we get a cleaner look at the actual sales data. We also see how strong or weak any given year is. Note that for the longest time, much of the media got this wrong, misreporting month-to-month data as a recovering housing market, instead of as part of the usual annual cycle.
Since the financial media is spoon fed by the National Association of realtors, it isn’t surprising it’s often wrong or spun to create a false impression of strength.
Let’s take a look at July: Last month — shown as a red column — had 43,000 new home sales, the highest July sales figure since 2008. In July 2014, the number was 35,000. It pales, of course, to the all time July high in 2005 — that was 117,000 — but it’s a lot more than the recent July low of 26,000 in 2010.
2005 was unusually high, but the long-term average is still nearly double recent sales volumes.
The good news is that the Census Bureau reports new home sales so far this year at 316,000 — again not seasonally adjusted — up 21.2 percent from the same period last year. The bad news is that, despite record low mortgage rates, these numbers are still close to what we used to think of as cyclical lows.
That brings us to our second chart: 50-plus years of new home sales and recessions. As you can see from the yellow line, new home sales are now just above the lows of earlier recessions as shown by the light blue bars.
I reported on this back in 2013 when New home starts surpassed lowest pre-bubble low of last 45 years. Even then, the glass-half-full crowd touted the strong recovery.
There are a couple of reasons why new homes sales are trending so much below their historic averages. First, the post-credit-crisis recovery has been (as expected) modest at best. This includes weak wage gains combined with tightened standards for extending credit to buyers. That alone accounts for much of the weakness in both new and existing home sales.
Second, and more specific to new homes, that giant decade-long boom from 1998 to 2007 created a huge oversupply of new construction. That fulfilled (perhaps “exhausted” is a better word) much of the demand for new homes.
Third, maybe most significant to new home sales, the aftermath of the financial crisis created a huge number of distressed sales — foreclosures, short sales and owners desperate to sell and reduce debt. Losses taken by banks and homeowners acted as net discounts to buyers, which functioned as price competition to new construction.
So it’s not too much of a surprise that the recovery in new home sales is lagging the recovery in existing home sales. Builders should be happy that sales of distressed properties have been falling to the point where competition for new homes is waning.
Also back in 2013 I reported that Low MLS inventory was a boon to homebuilders. The slowdown in foreclosures caused the MLS inventory to evaporate, and the result of the federal reserve stimulus and the lack of MLS inventory is a supply of homes that fails to meet demand. Builders take advantage of the situation to ramp up construction to deliver the supply the banks are not.
Will this weak recovery in new home sales continue?
I expect that will be a function of the health of the economy at large, in particular employment and wage gains; how soon credit availability swings back toward normal; and how fast and high the Federal Reserve takes interest rates.
All of those factors are in play, but the more basic truth is that housing’s performance is so bad, it can’t help but get better. There is really no way to argue with this contention because it’s an appeal to faith. You can easily imagine this specious argument being made by housing bulls in 2006 when sales dropped from 1.4M to 1M annual sales, and again in 2007 when sales dropped from 1M to 600K annual sales, and again in 2008 when sales dropped from 600K to 400K, and every year since when sales languished at 50-year record low levels. We are still only building a few more homes than we did at the bottom of the worst recessions since 1962.
I suppose it can only get better… eventually. Is the glass-half-full interpretation particularly helpful?