Recent data suggests an improvement in US housing activity. Although residential construction is not as significant a component of GDP as it once was, dropping from 6.5% of GDP in 2005 to just over 2% of GDP now, we monitor all the housing data closely because the numbers remain important indicators of the health of the US economy. In November, there was a 4.0% month over month increase in existing home sales, which was 11% above the July level. New home sales rose by 1.6% in the same period and 7% from July. Information from the National Association of Realtors reflects that most of the activity came from first time buyers. In December, starts in single family homes increased 4.4% over November, mitigating a 20.4% drop in multi-family starts. Although this is generally encouraging news, the data can prove to be erratic. We would expect the multi-family sector to do better because of increasing rental activity. While recent information may indicate that residential real estate prices have found a bottom, we remain vigilant. It would seem that new construction could not fall much further; but, it did decline 2.2% month over month in December. That is a 7.3% decline from the previous December, and just 10% above the low reached in mid-2010.
Thirty year mortgage rates have fallen to the 4% level, a record low. Furthermore, banks have loosened their down payment requirements to 20% from 25%. Even with these lower rates, the spread over Treasuries is relatively high, making mortgages attractive once again for banks and investors. The recent announcement by the Federal Reserve that it anticipates keeping the Fed Funds Rate low well into 2014 means mortgage rates will remain low for the immediate future. The Federal Open Market Committee recently stated that there were significant downside risks to their “modest” growth outlook over the coming quarters. Some form of quantitative easing in March or April involving the Fed purchasing mortgage backed securities would reinforce the low interest rate outlook for this year.
Both the number of existing homes for sale and the months’ supply of total unsold homes have returned to historical norms. Nonetheless, house prices could still fall further. As with any market, prices tend to over shoot their benchmarks before reverting to their historical mean. Why might that happen and what would be the consequences?
Foreclosures are apt to increase as state officials reach agreements with banks and mortgage service providers over poorly documented loans. In Florida, where “robo-signing” was a particular scandal, it now takes about 750 days to foreclose on a piece of property, up from 170 days prior to the real estate meltdown. As properties become foreclosed, they are quickly auctioned off at prices substantially below market. There are approximately 3.5 million mortgages in foreclosure or more than three months past due. Additionally, we all know people who have held their houses off the market because they do not want to “give their house away.” Gary Shilling has looked at the data and concluded that it could take five years at current absorption rates to work off the estimated excess inventory coming on the market, possibly putting further downward pressure on prices.
Any additional decline in house prices would reduce home equity, inducing more people to walk away from their underwater mortgages. The negative impact on consumer confidence would ripple through an economy already vulnerable to bad news.
We would like to see confirmation of a positive inflection in the housing data before adding risk to portfolios.