Are We On the Road to Normalization?

By Lawrence Yun, Chief Economist, NAR Research

Ah, the dog days of summer. Many are taking advantage of their last chance this season to sit on the beach, hike in the mountains or laze by the pool before the kids go back to school and everybody has to go back to work. Well, while a lot of us have been on vacation, the housing market has been relatively busy compared to earlier this year and even last year at this time. Indeed, recent figures on home sales – both pending and closed indicate that housing market recovery prospects have improved considerably. Pending home sales (contract signings) in June released earlier this month rose again for a fifth consecutive month. We’ve also seen downward trends in housing inventory and distressed property home sales. Both of these developments suggest that the market is moving back towards more normal conditions. Let’s take a look “behind the numbers.”

NAR’s Pending Home Sales Index reached 94.6 in June, its highest mark in two years and a vast improvement from the cyclical low of 80.4 in January of this year. If buyer contracts persist at this level, the corresponding home sale closings would be about 5.2 to 5.5 million at an annualized rate. For comparison, last year existing home sales totaled 4.9 million. We’re on our way to that: in June, existing-home sales increased for a third consecutive month, posting 4.89 million seasonally adjusted annualized units.

The rising sales have eaten into the bloated inventory. In June the number of existing homes available for sale declined. A year ago (June 2008) inventory stood at 4.5 million units; this June there were 3.8 million homes on the market – a 9.4 months’ supply at June’s sales pace. If pending sales continue on their current track – and if all pending sales become closed transactions – that will bring housing inventory down to under an 8-months’ supply before year’s end. What a sharp improvement from the double-digit months’ supply last year.

Of course, there are great variations locally on months’ supply. For instance, the Minneapolis market posted a 6-months’ supply of inventory -- essentially “back to equilibrium.” That will likely mean normal price growth expectations of 3 to 5 percent per year. Other examples include Orange County in California and some markets in Florida where housing inventory is at or even below the normal months’ supply conditions.

Risks, however, still remain. There has been some concern about ‘shadow’ inventory – that is, some foreclosed properties held by banks which have not yet reached the market or are being purposely “held back” so as not to flood the market. Such shadow inventory could mask the downward inventory trend.   In addition, many believe that there is a substantial number of homeowners just waiting for the market to improve before putting their home on the market. Accordingly, any fall in inventory should be viewed as a short-term fluke. But this view is not panning out in the real world. The recovery process has been uneven across the country. Those markets that have been recovering for some time should already have witnessed the rise in the release of these shadow inventories onto the market. And the data shows that these recovering markets have consistently recorded inventory trends declining and declining.Whatever the level of shadow inventory that was present, the impact has been minor.

In addition, many people – especially those who have lost their jobs – are concerned about foreclosure. It is likely that foreclosures will continue to rise through the remainder of the year. But unlike this time last year, today’s home buyers are fighting over the foreclosed properties. Consequently, any newly foreclosed homes will not linger in the marketplace for long. While the first-time homebuyer tax credit has no doubt helped kickoff the rising sales trend, this program is set to expire at the end of November. Realtors® and consumers need to be mindful that it is the settlement and not contract signing that must occur by the expiration date. Given the much longer time it has been taking to close on a home due to appraisal issues and the additional paperwork that mortgage lenders need to supply to consumers, contract signings should be done by late September to comfortably meet the IRS tax credit deadline. In my view, there are a sizable number of potential first-time buyers who may not make the deadline. Long-term rental contracts, the time needed to come up with a down payment, and the search time required to find that right home will hinder some from taking advantage of the tax credit in time. Simply put: the deadline period needs to be extended to at least mid-2010 so that more people are able to benefit from the stimulus package. More importantly, such an extension is needed in order to get the economy firmly back on track to avoid any double-dip recession possibility in 2010.

Why is housing the key to sustainable growth? It is because consumers’ wealth is tied to the strength of the housing market. When home prices fall, people feel poorer and so reduce their spending. Consumer spending is vital to economic growth (in fact consumer spending accounts for around 70 percent of the nation’s GDP). Furthermore, falling prices, lead more homeowners to be deeply under water and thus lead to rising foreclosures. Rising foreclosures in turn will eat up bank capital and so lower the flow of credit. With less money able to circulate, the economy could face a double-dip recession.

If home values were to stabilize or even grow, then households will regain confidence to spend more on all items as their wealth situation improves. Rising home values will also reduce foreclosures and permit banks to lend more, which will help businesses – small and big alike - to borrow more easily to expand and for the economy to grow. In addition to the broad macroeconomic and credit market stabilizing impact, each home sale generates about $65,000 in economic activity: from using moving trucks to buying furniture and appliances. Furthermore, the thinning of the inventory will allow for home builders to start hiring construction workers. Rising home values also help with local tax revenue – this is money that stays in your community. In other words, this is local money for local people.

As for the economy, it too appears to be clawing back to normal. The preliminary GDP growth figure for the second quarter of this year was -1.0 percent – significantly better than the -6.4 percent registered in the first quarter. In fact, overall production in the economy is expected to show growth in the third quarter, with many economists now calling for an end of the recession by September.

The economy will get a temporary boost as auto producers crank up production. The Cash-for-Clunkers program clearly shows that people do respond to incentives. But unlike the home buyer tax credit, the Clunker program necessitates a ‘destruction’ of a working asset, albeit an inefficient one. Also unlike the home buyer tax credit, which can lead to a momentum building trend of rising future home sales and a sustainable economic recovery, a rise in auto sales now will most certainly result in a fewer auto sales later when the Cash for Clunkers program ends.
There are more signs that the economy is shooting up. Durable goods orders have risen for three straight months. It will rise further because business inventories have all but been depleted. The severe credit crunch of last autumn prevented any business spending for inventory restocking. The stock market has also made a nice comeback. Exports have been rising faster than imports. This is all good news going forward towards a non-recessionary economy.

There was even some “sort of good news” about jobs. The all-important employment data for July showed the lowest level of job cuts all year. The 248,000 payroll job cuts in July was large, but notably lower than over 600,000 per month job cuts in the early months of this year. Interestingly, the unemployment rate dipped to 9.4 percent in July from 9.5 percent in June, but was this was likely due to fewer people actually in the workforce. Remember: the government statisticians count people as unemployed only if a person does not have a job and is actively searching for one. Discouraged workers who are not working – and not looking because they have temporarily lost hope of finding a job – are not counted as unemployed. These discouraged workers will, surely, re-start the job search as economic news improves. Therefore, expect the unemployment rate to rise higher. I expect 10.5 percent peak, before any consistent downward movement early next year.

A risk of a jobless recovery or even a double-dip recession is small but not negligible. The federal budget deficit needs to be addressed. The anticipated $2 trillion budget deficit this fiscal year is simply not sustainable. Aside from burdening the future generation in some distant time, an out-of-control situation could lead to significantly higher interest rates and mortgage rates immediately, which will choke off both business spending and housing recovery. Another concern is the rising oil prices. It is above $70 per barrel. It had been below $50 for most of this year. The $20 higher charge is extracting roughly $400 million out of the economy each day – with the most of the money shipped abroad. If the higher oil price is sustained at $70 or moves even higher, economic growth could be anemic and push the unemployment rate to possibly 11 percent – which would be the highest since the Great Depression.

The recovery in the housing market will lay the foundation for a sustainable economic recovery. With more sustained economic growth, jobs will be created. Job growth is what is needed for consumers to buy furniture, computers, a host of consumer products, and lead to a sustainable rise in auto sales even without the clunker incentives. Despite the risks facing us, our baseline economic forecast still looks much better – with higher home sales, stabilizing home prices, and an eventual recovery in jobs.