Inventory and the Low Equity/No Equity Homeowner

Pending Home Sales index for December 2012 was released this morning. The data itself was mixed — down 4.3% from November (SA) but up 6.9% year over year. The index is a measure of housing contract activity, based on signed real estate contracts (existing single-family homes, condos and co-ops).

The spin from the NAR is always amusing, and this report is no different. How the NAR framed this, and what it might mean going forward, is rather interesting. NAR chief economist Lawrence Yun made the following statement: “The supply limitation appears to be the main factor holding back contract signings in the past month. Still, contract activity has risen for 20 straight months on a year-over-year basis.“¹

Yun is onto something, but he doesn’t seem to really understand what it is. Supply limitation is an important factor, but why supply is limited is an even more important factor. Understanding the inputs into this directional vector is significant if we want to discern where housing may be heading this year. Said differently, the factors underlying the limited supply matter much more than the supply itself.

On the positive side:

– Fed has taken rates down to very low levels
– Employment has been improving (albeit slowly)
– 7 years have elapsed since the RE market peaked in 2006
– $25 billion dollars or so of Private Equity funds has been purchasing real estate for a “Rent-to-resell” model
– Confidence is coming back that the crisis is behind

On the negative side:

– Low rates will eventually rise, capping price appreciation
– Growth is inorganic, artificially spurred by the FOMC
– Wages have been flat
– Banks are still sitting with millions of REOs, waiting for price appreciation
– 20% of home owners with mortgages are underwater
– 20% of home owners with mortgages have little or no equity.

Those last two data points come from Jonathan Miller, who calls the current environment a “Pre-covery.”

“Sellers, when they sell, become buyers (or renters) and with >40% of mortgage holders having low or negative equity, they don’t qualify for the trade up. We have been so focused on negative equity that we’ve paid short shrift to the impact of low equity.

Not only don’t many sellers qualify – they simply aren’t under duress i.e. they haven’t lost their job, don’t need to move, etc. so what will they do when they realize they don’t qualify? Nothing.“

There is the reason for what the NAR has correctly identified as the basis for falling prospective sales index: The lack of inventory.

But it is not the kind of shortfall they think it is. It is not “If we only had more houses, we could sell them.” Rather, its more of “The lack of equity is causing both a lack of homes for sale and a lack of potential new buyers.”

What fixes these problems? More Household formation, increased employment — and increased wages. As those three go, so goes Housing.

See also:
Pending Home Sales Down in December but Remain on Uptrend
January 28, 2013
http://www.realtor.org/news-releases/2012/10/pending-home-sales-down-in-december-but-remain-on-uptrend

Falling Inventory Has Created a Housing “Pre-Covery,” not “Recovery” 
Jonathan Miller
Miller Samuel January 28, 2013
http://www.millersamuel.com/blog/falling-inventory-has-created-a-housing-pre-covery-not-recovery/28093   

A New Housing Boom? Don’t Count on It
ROBERT J. SHILLER
NYT, January 26, 2013   
http://www.nytimes.com/2013/01/27/business/housing-markets-future-still-has-many-clouds.html

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1. Note that when home sales were falling, their emphasis was on monthly data, but let’s save that for another time.

 

click for larger graphic

Source: Calculated Risk