Friday, August 29, 2014

Comprehensive housing summary for July 2014: prices peak, but lower interest rates are putting an end to the sale slowdown

Wtih yesterday's report on pending home sales, housing data from the first 7 months of 2014 is in the books.  The data clearly shows that earlier this year was the trough of the housing slowdown, and that lower mortgage rates - down over .5% from the beginning of this year - are beginning to have a positive impact. At the same time, it appears that housing prices hit an interim peak earlier this summer, and are stabilizing if not in a slight decline.

I've seen some very poor analysis of the housing market, that I won't link to, in the last month.  For example, I've seen an argument, unsupported by actual data, that prices or even inventory, rather than interest rates, lead sales. This is demonstrably false if you simply look at the data.

You really need to remember the following.  The housing market tends to cycle in a regular order:
  • 1st, interest rates turn
  • 2nd, permits, starts, and sales turn
  • 3rd, prices turn
  • 4th, inventory turns
Because of the time lag, prices and inventory may still be reacting to a move in interest rates that has since reversed - and that appears to be the case now.  July is when the turn in rates and prices became clear.

Interest rates

First, here is a graph, covering the last 30 years, of the YoY% mortgage rates (inverted so that higher rates give a lower value, blue) vs. housing permits, YoY change in 100,000's (red):

Here's a close-up of the last 5 years through July:

Interest rates on mortgages went up from 3.4% in early May 2013 to a high of 3.6% in August of last year.  On 16 of 19 occasions since the end of World War 2, that big a change led to a YoY decline of at least -100,000 in permits. In this case, housing permits drifted back lower, down to 4.1% at the end of June of this year, and in the last month have been on average about -0.3% lower than they were at this time last year.

The YoY decline in interest rates suggested that we would start to see some improvement in permits, sales, and starts, although probably muted since rates have not returned to 2013 lows.  In July, in two of the three series, we did.

Permits, starts, and sales

Here is a graph of the change, in thousands, YoY of starts (blue), permits (red), new home sales (green), and existing home sales (orange) (note that the St. Louis FRED does not track pending home sales):

Next, here is the YoY% change in the same four statistics:

Both of these graphs show the clear deceleration in the housing market through 2013 and into outright  declines in the early part of this year.  New and existing home sales have been consistently negative YoY, and permits ended up at midyear only +2% in the first half of 2014 compared with the first half of 2013.

But with July's data, we can see that the trough of the housing slowdown is in place, and that there has been a significant positive turn in the last several months.  Only pending sales were negative YoY by -2.1%, although they were up month over month for the fifth month in a row.

In summary, through July 2014:
  • Permits are down -0.9% from their October 2013 high, but up +12.6% from their January 2014 low
  • Starts are down -1.1% from their November 2013 high, but up +21.9% from their Januay 2014 low
  • New home sales are down -9.8% from their January 2013 high, but up +2.2% from their March 2014 low
  • Existing home sales are down -4.3% from their July 2013 high, but up +12.2% from their March 2014 low
  • Pending home sales are down -2.1% from their June 2013 high, but up +12.4% from their February 2014 low

The impact of demographics on permits, starts, and sales

I suspect the situation this year is analogous to the late 1960's (one of the four exceptions to the rule that rising interest rates cause an actual decrease in sales), when Boomers first reached adulthood and the existing apartment stock was nowhere near adequate to the task.  Multi-unit starts skyrocketed, despite higher interest rates, while single family homes languished. It was an era of generally rising interest rates, and any temporary decline in interest rates was met with heightened housing activity.

Now it is Millennials. Now as then, it is only multi-unit (apartment) construction that is carrying the recovery in housing this year. Even with the overall July increase, single family home starts and sales have completely stalled.  Here is a graph of the YoY% change in single family house permits (blue) and multi-unit permits (red) since the beginning of 2011:

Since late 2013, multiunit construction has been entirely responsible for any increase in residential construction.


 The Case Shiller 20 city index for July showed an actual decline from May and June.  By this important measure, prices have actually already made an interim peak:

Median prices for new homes (red) and existing homes (blue) are not seasonally adjusted, so I am showing their YoY% change, which shows continued marked deceleration in price gains.  Note that YoY comparisons lag seasonally adjusted month over month comparisons:

It is likely that we have seen an interim, seasonally adjusted price peak in housing.  It should decline for awhile before bottoming, as sales have already bottomed.


With housing prices still increasing YoY, even if they are near or at or slightly past their seasonally adjusted peak, we would expect to find more inventory entering the market, as potential sellers hope to take advantage of the improved pricing situation.  And that's exactly what we find. Below is the graph of combined new and existing home inventories:

The inventory of houses for sale is not just increasing, but it is increasing at an accelerating rate YoY.

In summary, through July 2014:

  • 1. Lower interest rates have revived sales from their trough earlier this year. At the same time, because interest rates are still higher than they were several years ago, I am not expecting a renewed boom in sales.
  • 2. As shown by the Case Shiller Index, prices hit an interim peak earlier this summer.  Because the lower interest rates are already feeding through the system, at this point I am expecting only a slight decline, or more generally a period of stable prices.
As I have noted a number of times in the last month, the biggest issue in the second half of this year is how much interest rates go down, and whether the decline is transitory or persists.  New housing sales are very important to the economy, and tend to feed through the entire economy over the course of a year or more.  For now, the trend is in the right direction.