Revisiting Housing

We received some welcome data yesterday on the housing front. New home sales for April rose 24% YOY, coming in at a seasonally adjusted annual pace of 619,000. This tally was handily above the consensus estimate of 521,000 and was the best monthly pace since April, 2008. Perhaps even more impressive, the median sales price for those new homes rose 9.7% YOY to $321,100. These data points indicate that the demand for newly constructed homes has improved fairly dramatically. Together with the strong Retail Sales report for April (reported on May 13), the data also boost the narrative of an incrementally more confident consumer. Prior to these two reports most data had suggested that the consumer remained very cautious with a greater propensity to save both income increases and the windfall from lower energy prices. Perhaps we are seeing a tide shift.

5-25 1Source: US Census Bureau.

Of course, new home sales are just one piece of the housing puzzle as they make up only about 10% of total home sales in any given period. It is true that economists place disproportionate weight on new home sales because the construction of new homes creates solid middle-class jobs and leads to other economic activity. But far more important to the health of the overall housing market are existing home sales, which comprise about 90% of total sales. Fortunately, the data on existing home sales has been steadily improving as well. Last Friday we learned that existing home sales came in at an annual pace of 5.45 million in April, which was up 6% YOY and close to a 9-year high. The median price for these sales grew 6.3% YOY to $232,500, which is approaching the monthly record of $236,300 posted in June, 2015. Again, there is a lot to like in this data.

5-25 2Source: National Association of Realtors.

The ongoing trajectory of the housing recovery will obviously depend on supply and demand. Setting aside the supply constraints for now (which are considerable given that the current supply of existing homes for sale at 4.7 months is well below the 15-year average of 6.2 months), we think the largest single factor driving sales activity and pricing will be the level of mortgage rates. The chart below shows pretty clearly that the recovery in housing prices has been heavily dependent on steadily decreasing mortgage rates to near-record lows. What will happen as interest rates rise should be fairly predictable. Will rising consumer incomes be enough to offset the headwind of higher mortgage rates? Time will tell, but we remain skeptical for now.

5-25 3Sources: Freddie Mac, S&P Case Shiller 20-City Home Price Index, National Association of Realtors.

Another factor driving the housing recovery will be the level of household formations. Formations spiked from late 2014 to late 2015, but have since dropped precipitously to below the 10-year average. The drop is undoubtedly related, in part, to the aforementioned supply constraints, which are especially affecting first-time buyers. As housing prices continue to rise and more younger people become priced out of the market, will housing turnover slow? How will this affect pricing? We think this issue will receive more attention as college graduates, saddled with massive student debt, are simply unable to join the ranks of the home-owning population. Will there be a political response to this issue, such as a reduction in interest rates on government student loans? Time will tell.

5-25 4Source: Bloomberg Intelligence.

Perhaps as important as the stronger housing data is the stock market’s response to the strong data. It seems pretty clear that at least some of the market strength over the past couple of days reflects an investor response to this improving housing data. We have been waiting for what seems like an eternity for good news to be embraced. Throughout the recovery from the financial crisis, good news had been greeted negatively as it increased the likelihood of Fed interest-rate hikes. Conversely, bad news has been greeted positively on a fairly consistent basis as the Fed would remain at full throttle. We’ve asked this question numerous times over the past 7-8 years, but are we finally seeing a reversal of this trend? Only time will provide the answer to this question as well.