Best Existing Home Sales Since 2006
Good news has been hard to find on Wall Street these days, so the Existing Home Sales report on Friday was a breath of fresh positive air. December's existing home sales shot up 14.7% from November, topping all analysts’ estimates.
That number is a bit misleading, since November sales were artificially low thanks to the October implementation of the "Know Before You Owe" program from the Consumer Financial Protection Bureau (CFPB). The new rules simplified and standardized the forms that consumers are presented with during a home purchase in order to make the terms more understandable. Implementation of the new rules delayed a significant number of November's home sales into December. Knowing this, analysts expected a large bounce back, but the 5.46 million annualized rate surpassed the Bloomberg estimates of 5.00 to 5.45 million.
Actual 2015 existing home sales rose by 320,000 to hit 5.26 million, for the best year since the 2006 total sales of 6.48 million. That's a positive sign for economic recovery, but is it sustainable?
Squeezed By Supply
Basic supply and demand, combined with other aggravating factors, suggests that the housing market will be hard-pressed to top 2015's performance. The National Association of Realtors (NAR) agrees. Lawrence Yun, NAR's Chief Economist, suggests that a potentially thriving housing market will be throttled by limited supply, slow economic expansion, increases in mortgage rates, and the continued housing slump in oil-producing markets. Yun predicts only a 1% increase in existing home sales for 2016.
New home sales increased markedly through the year, with a 15% increase during the first 11 months of 2015. Earlier in the week, the Housing Market Index from the National Association of Homebuilders (NAB) slid slightly from 61 to 60, suggesting that there is still cautious optimism about the housing market (anything above 50 indicates expected growth). However, within that report, the traffic component has fallen to 44, lagging all other indicators and highlighting poor participation from first-time homebuyers.
A 2015 Zillow report showed that first-time homebuyers were waiting longer than ever to convert from renting to owning — six years on average. Surely, some of this is due to the increase in home prices and rents compared to flat wages. It simply takes even longer for millennials to save up enough to buy a home. Median existing home prices rose 6.7% throughout 2015 to reach $224,400. The increased value tempts existing homeowners to upgrade, but there's a catch.
Initial homebuyers are the critical "pump that primes the market." Without sufficient first time homebuyers, those who want to upgrade their home have a more difficult time selling their existing home. With a short supply of homes that match the needs of buyers, prices are rising, making it even more difficult for first-timers to get into the market. NAR shows a 3.9-month supply of available existing homes — well below the 6-month supply considered to be a sign of a healthy market.
It's not a grim picture when placed in context. New home construction is at its highest level since 2007 while first-time homebuyers made up 32% of all purchases (the best since August). Payrolls in December rose enough to make 2014-2015 the best consecutive years for employment since 1998-1999. While last week's December Housing Starts report dropped slightly from a strong November reading, Bloomberg points out that the overall trend points to "respectable strength" for new housing.
Clearly, the situation is improving, although housing numbers remain well below pre-boom levels — where they are likely to stay for a year or two without a significant increase in economic growth.
The Role of Interest Rates
Now that the Federal Reserve has begun to raise interest rates, mortgage rates will follow suit... or will they? For now, they have not raised significantly. According to Freddie Mac, the 30-year fixed mortgage rate was 3.81% on average at the end of the week, the lowest value since October. When the Fed raised interest rates in December, rates were at 4.01%.
There are two likely reasons: Fed changes are not always immediately passed on as higher mortgage rates, and the Fed's change was extremely small at 0.25% Should the Fed continue with their planned 3-4 increases of 0.25% in 2016, mortgage rates will begin to rise enough to seriously affect the housing equation and put a greater squeeze on potential homebuyers, as the NAR's Yun suggests.
If that happens, it’s important to keep mortgage interest rates in context, because even a 1% increase will allow rates to remain low by most historical standards. Given the chaotic stock market of the first quarter, some analysts are already hedging that the Fed will stick to their modest 1% increase for 2016, so it seems unlikely that mortgage rates will do anything more than slowly creep up throughout the year.
By themselves, 2016 interest rates should not be a hindrance to a housing market recovery. Combined with the factors noted by Yun, and a tight lending market thanks to the Dodd-Frank Act and similar reforms, the collective drag on housing will keep growth muted, but it is not likely to stop it entirely.
Expect the housing market to track the economy broadly, with reasonably slow growth, but not the wild gyrations of the stock market. It is going to take time to break the chicken-and-egg cycle of housing supply and skittish first-time homebuyers. Homebuilders understand this and are not overextending themselves to build entry-level housing, but they are continuing to build on the positive future signs (pun intended).
If you are one of those nervous first-time homeowners, you have a bit more time to gather the necessary down payment and build up the nest egg, but you should be at least looking at homes that interest you. Interest rates and home prices are likely to continue to increase, and you should probably aim to buy relatively soon before the increases outpace your nest egg and payment capabilities.
Set a future target date for a home purchase to keep you on track and take the time to shop around for the best rates. If poor credit is hampering your ability to get good rates, work on that first. You cannot control the baseline interest rate, but you can control your ability to get that rate through superior credit.
From the investment side, residential real estate remains a tough market with tight supply and rising prices, but there are deals to be had for experienced investors. If you have less experience in the field, you may want to consider REITs (Real Estate Investment Trusts) instead, as they have historically sound returns with less risk.
The housing market had quite a hole to climb out of, and it will eventually do so, as recent trends suggest. In the short term, however, patience is still required.