U.S. Existing Home Sales: A Tug of War

Two competing forces are driving existing home sales. Distressed sales (foreclosures and short sales) in three western states are driving sales up. Driving housing sales down is weak demand across most states. In January, weak demand won out.

The tug-of-war between these forces shows up better in the quarterly numbers, which the National Association of Realtors (NAR) released on February 12, than in the monthly ones. According to the quarterly data, fourth-quarter year-on-year sales were up in six states: Nevada (up 133%), California (up 84.7%), Arizona (42.6%), Florida (up 12.5%), Minnesota (up 7.2%), and Virginia (up 3.1%). Sales were down in 44 states. These numbers were similar to those for the third quarter. The NAR data also show house prices declining almost everywhere, but falling the most in cities within these states. Seven of the 14 metro areas experiencing the greatest price declines were in California, along with three in Florida, two in Michigan, and the other two in Arizona and Nevada. The Federal Housing Finance Agency released quarterly state housing prices data yesterday (February 24) showing prices in the fourth quarter dropping the most in Nevada, followed by California, Florida, and Arizona. These are the states hit hardest by the foreclosure crisis.

At some point, prices will drop so much that sales will start to pick up. So far, this has yet to happen, despite the fact that housing is as affordable now as it has been in decades. Indeed, the NAR's affordability index rose to an all-time high of 158.8 in December (data start in 1971). This means a family earning the median family income has 158.8% of the income necessary to qualify for a conventional loan covering 80% of a median-priced existing single-family home. In July 2006, the index bottomed at 99.

The months' supply of existing homes for sale—the yardstick used to measure excess supply—increased 0.2, to 9.6 months. This is still better than November's reading of 11.0 months, but the improvement may be illusory because of the "phantom inventory" problem. "Phantom inventory" refers to homes for sale that are not listed with realtors, and are therefore not included in the NAR's database. According to anecdotal evidence, a significant proportion of foreclosed homes are part of this phantom inventory.

A second inventory measure, the Census Bureau's homeowner vacancy rate, which measures the proportion of single-family homes vacant and for sale, rose to an all-time high of 2.9% at the end of 2008, despite the sharp contraction in single-family housing starts. This translates into an excess supply of nearly 1 million homes. Normally, given the depressed level of housing starts, underlying housing demand (demand from new household formation, demand for second homes, and replacement demand), would eliminate this excess in about one year. However, many who have lost their homes to foreclosure, or who have lost jobs, are moving in with family or friends, suppressing underlying demand.

Other indicators confirm that the housing downturn has intensified. January's housing starts report was probably the worst ever. Not only did total housing starts, total housing permits, and single- and multi-family starts plunge to all-time lows, but declining permits over the previous three months point to significant declines in starts during both February and March. New home sales also sank to a record low in December, as did the NAHB/Wells Fargo Housing Market Index (although this index inched up a point in January).

Market conditions for new homes have not been this bad since the 1930s, and they continue to worsen. In recent months, several factors that will extend the downturn in housing starts have come into play. First, the household formation rate has slowed, as homeowners losing their jobs or homes to foreclosure have moved in with family. Second, rising foreclosure rates have driven down the prices of existing homes, pricing new homes out of the market. Third, the credit crunch has made it difficult for builders with viable projects to obtain financing. Finally, the severity of the downturn and the stock market crash has reduced demand for long-lasting goods such as automobiles and new first and second homes. These factors will continue to play a role during 2009.