Eye on the Economy: Home Sales Slip in July


New and pending existing homes sales in July disappointed analysts with monthly declines, but are not indicative of a larger retreat for the overall recovery in housing. Demand for homes will continue to grow with labor market expansion, unlocked pent-up demand, and an improving overall economic environment. For builders, low inventories point to continued growth in housing starts. And housing continues to contribute to economic growth, with overall construction spending for all three legs of home building (single-family, multifamily, and improvements) up in July.

According to the Census and HUD, the annual rate of new home sales dropped 13.4% to an annual rate of 394,000 in July. All four census regions saw declines ranging from 5.7% in the Northeast to 16.1 % in the West.

The drop is the result of the jump in mortgage interest rates that began in May and accelerated in late June. The rise in rates first caused some acceleration in contract signing, as June sales were 3.6% above May even as mortgage rates rose about 50 basis points. Further increases caused buyers to pause in July. According to Federal Housing Finance Agency (FHFA) data, the average effective rate for loans for newly built homes increased for the second consecutive month, rising to 4.07% in July.

The dip in sales for July should be temporary as prospective buyers adjust to new financing costs. NAHB’s forecast for new home sales remains at 452,000 for 2013, or a 23% increase over the 2012 level.

Similar to new home sales, pending home sale contracts for existing homes also declined in July. According to the National Association of Realtors (NAR), the Pending Home Sales Index (PHSI) fell 1.3% in July 2013 to 109.5, although the index remains up 6.7% year over year. The drop in pending home sales suggests that future existing home sales will be lower. The NAR July existing home sales report indicated a 6.3% monthly increase, but is based on sales arranged prior to recent interest rate increases.

Rising prices have also eroded affordability for some buyers. The S&P/Case-Shiller House Price Index grew by 7.1% on a not-seasonally adjusted basis in the second quarter and is up 10.1% over the previous four quarters. Using different data, FHFA found that U.S. house prices rose by 2.1% on a quarter-over-quarter, seasonally adjusted basis and are up 8.1% over the past two years.

These price gains have the potential to push some buyers to the sidelines. For example, a rise in price that increases a monthly mortgage payment by 8% is similar to a 70 basis point increase in rates. Rising rates, higher prices and continued credit issues can have particular impacts on younger buyers. For instance, the NAR existing home sales data indicates that in July only 29% of buyers were first-timers, down from 34% a year ago and off from the approximately 40% historical average.

Changing market conditions have also affected newly built home sales via a shift from the purchase of completed homes in inventory to the sale of homes still under construction or not yet started. This shift is a product of several trends.

Eight of 10 new home buyers already own a home and have often refined their choices to the point where the current inventory does not fit their needs. Additionally, the number of completed new homes for sale dropped to a 40-year record low in June at 35,000. For comparison, the average from 1993 to 2003 was 2.5 times that level at 89,000.

Builders continue to meet resistance from traditional sources of credit, so one way around lenders’ reluctance is to couple the loan application with a signed contract or to have the buyer obtain a construction-to-permanent financing loan based on the purchaser’s credit. The use of construction-to-perm loans has increased from one-fifth of the market in 2010 to one-third in the second quarter 2013.

Over the recent cycle, the shift has been dramatic. Completed homes were half of sales in 2008 as sales slowed but inventory kept building. The average since 1963 is 36%, the level reached in 2012. By mid-2013, that share fell to 29%. Conversely, homes under construction comprised less than one-quarter of homes sold in 2008 but now make up more than one-third of sales.

Despite these changes, the rise in rates and other changes to housing demand do not mark the beginning of a retreat for housing. Pent-up housing demand remains on the sidelines, which will be unlocked for reasons related to demographic change and job market improvement. Rates and prices can determine the timing of purchases in the short run, as can asking prices from prospective buyers, but the underlying demand will be relatively unaffected over the long run by recent changes.

As an example of pent-up housing demand, a recent study from the Pew Institute found that the share of the U.S. population aged 18 to 31 living with their parents increased to 36%, a record of 21.6 million young adults. Prior to the Great Recession, this share was 32%. Part of this rise is technical, in that many young adults who attend college are classified as living at home.

And indeed, the number of young adults attending college rose in recent years, with the share of 18-24-year-olds enrolled increasing from 35% in 2007 to almost 39% in 2012, Pew estimates. When these millennials leave school, many will rent and eventually purchase a home, although student loan burdens remain worth examining in the years to come.

Additionally, improving macroeconomic conditions (GDP growth in the second quarter came in at a better-than-expected 2.5%) have resulted in an increase in the number of movers in recent years, helping to improve the sales volume in thin markets.

In 2012, nearly 12 out of every 100 Americans moved, an increase of nearly 4% or 1.3 million more individuals than moved in 2011. While the most common reasons for moving was to upgrade housing (16%), the share of those moving to cheaper housing declined for the fourth straight year to somewhat less than 9%: a significant indicator of improving conditions.

These improvements have benefitted both for-sale and for-rent housing. For example, the second-quarter reading of the NAHB Multifamily Production Index (MPI) increased nine points to 61, the highest reading since its inception in 2003. Both for-sale and for-rent multifamily conditions were improving, with the rental MPI component rising six points to 67 and the for-sale element increasing 16 points to 58, the highest reading since the second quarter of 2005.

Another headwind for builders may be easing, as the stock of acquisition, development and construction (AD&C) loans grew 2% in the second quarter. NAHB survey data also indicate ongoing easing of credit conditions for AD&C loans. However, despite this recent stabilization, there exists a lending gap between home building demand and available credit. Since the beginning of 2007, the dollar value of single-family permitted construction is down 39%. During this same period, home building lending for AD&C purposes is down 79%.

Additional data for home building in the second quarter detail the kinds of construction being undertaken. According Census data, single-family attached (townhouses) starts totaled 19,000 for the quarter, compared to 18,000 during the second quarter of 2012. Using a one-year moving average, the market share of townhouses now stands at 12.5% of all single-family starts, up from 11.2% for the second quarter of 2012.

Single-family starts built for rent were down sharply on a year-over-year basis, falling to only 5,000 starts for the second quarter of 2013 compared to 9,000 a year prior. The market share of single-family homes built for rent, as measured on a one-year moving average, stands at 5% for the second quarter of 2013. This remains significantly higher than the historical average of 2.8%, but is down from the 5.8% registered in the first quarter.

Owner/contractor-built starts (building for which the eventual home owner owns the lot) were almost unchanged from the second quarter of 2012 (37,000 starts) to the second quarter of 2013 (38,000 starts). However, as the rest of the single-family construction market expanded, the market share of owner- and contractor-built housing has fallen significantly. As measured on a one-year moving average, the market share has fallen to 21.8%, down from a cycle high of 31.5% set during the second quarter of 2009.

Finally, 2012 Census data of home completions reveal the geographic popularity of certain home features. For example, the data indicate that 90% of homes started in 2012 in Alabama, Kentucky, Mississippi, and Tennessee had porches or patios.

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