Yes, Clouds DO Have Silver Linings

From Real Estate Insights, The Forecast

NAR’s latest pending home sales index point toward soft sales conditions for the remainder of the year. Of course, there are large local variations, but for the nation as a whole, closed transactions in the fourth quarter will be their weakest in seven years. The subprime loan bust, the still not-back-to-normal jumbo loan market and the usual lag time effect will account for the current quarter soft figures.

It's Not All Bad

But there is good news. FHA loan applications and approvals have been rising strongly. HUD’s endorsement of FHA loans for home purchases rose by 58 percent and that for refinances rose by 23 percent compared to a year ago. NAR has been lobbying heavily in the past year for a major FHA reform for greater flexibility and a higher loan limit. Those reforms could greatly increase the use of the FHA program, and there is a strong possibility of that occurring by early next year. Therefore, many potential first-time home buyers who in the recent past may have relied on subprime loans will be able enter the market with a safer and lower interest rate mortgage product. The increase in FHA loan usage will further accelerate in 2008.

There is also some discussion of raising the loan limit of Fannie/Freddie repurchased loans, which would measurably lower home buying costs in high-cost regions from California and Seattle in the West to the Boston, New York, D.C. corridor and parts of south Florida in the East. Such a change will lower jumbo rates by more than 50 basis points. On a loan of $600,000 – not an uncommon amount in high cost regions – the lower rates translate into savings of $4,000 per year for home buyers.

More Good News

Other positive factors. Currently, mortgage rates are generally lower. The average mortgage rate was approaching 6 percent in mid-November, down from 6.5 to 6.8 percent that we saw this summer. And while sales have been declining, the pent-up demand from steady job gainscontinues to climb. Since the home sales peak in August 2005, 5.4 million jobs have beenadded to the economy.

And good news about the economy continues. The economy was surprisingly strong in the third quarter of this year – and last two quarters posted near 4 percent GDP growth. Exports were dominant with a 16 percent increase. The prolonged dollar decline has actually helped U.S.-made products be competitive overseas. The usual negatives accompanying a weak currency – higher inflation and higher interest rates – have not appeared.

The weak dollar will also help in foreign purchases of American properties. The latest NAR survey on international buying trends – buyers from foreign countries purchasing U.S. homes – shows that more REALTORS® experienced increased activity from foreign buyers than decreased activity by more than a two-to-one margin. Mexico, Britain, and Canada were the top three countries of origin for those foreigners buying second homes in the U.S.

Some Concerns Down the Road

There are some concerns. The economy looks to show a very weak fourth quarter. Recent data on retail sales along with continuing large cutbacks in home building will hold back economic growth to about only 1 percent. But going forward into 2008, GDP should improve. Exports look to be strong, particularly if oil prices were to drift lower as the futures market indicates. Consumer spending will move ahead, albeit at a slower pace in 2008 – income gains from job gains will offset falling housing wealth spending impact. Any positive consumer spending growth virtually assures that the chances the economy will drift into recession are low given solid performance in exports and business spending. The odds of a recession in 2008, in my view, are 10 percent.

Housing

Consumers do need to contend with modestly lower housing wealth. NAR forecasts that prices will post a national price decline of 2.5 percent in the fourth quarter of this year. By the first quarter of 2008 though, price declines will be minimal as current widely available mortgage products filter through the system. Keep in mind that roughly 2/3 of local markets will haverecorded a positive price growth for 2007, and as we have often said all real estate is local. In 2008, many markets in the middle part of America, spanning from the Appalachian Mountains to the Rocky Mountains, could see decent price gains. These markets show “undervalued”conditions currently when viewed in relation to their historic local mortgage obligation-to-income ratio.

Housing Indexes

NAR relies on timely MLS data that provides the earliest signals about price trends. Other price forecasts rely on other sources. The Case-Shiller price index, for example, relies on data collected with a lag time using mortgage securities and county record data. That lag time can besignificant: people close on a home and only after several months do mortgage securities and county recording offices pick up the information. Consequently, the Case-Shiller price index will show the underlying NAR trend with about a 3 to 6 month lag time. Furthermore, the index’s data is subject to constant revisions because its methodology demands it. What is reported currently may be way off after one or two years and so the index is constantly revised.

In addition, the Case-Shiller index is price weighted. It was created with hedge funds in mind – where a $1 million mortgage loss is ten times greater than $100,000 mortgage loss, so this index gives greater weight to larger priced homes. In contrast, NAR’s price series treats all homesequally and reports the middle (median) home price. Most consumers appreciate equal treatment and timely information. NAR also covers nearly 150 markets while Case-Shiller covers only 20 – and those 20 happen to be weak markets currently.

The labeling of the Case-Shiller index is also misleading. Though it is called a monthly index, it is actually a prior rolling 3-month average. Because its data coverage is thin (compared to NAR’s as well as others) this 3-month averaging is necessary (although it seems to have been able to fool some in the media). And while I’m not suggesting that it be ignored, the Case-Shiller index should be read with caution.

Mind-set

There is more uncertainty related to our home sales forecast due to the greater psychologicalimpact on potential home buyers. The forecast for home sales is for only a 0.4 percent rise nationally. (All real estate is local so markets like Wichita could see a big jump in sales from strong rise in local employment.) If buyer confidence returns, home sales could turn out to be measurably higher.

- by Lawrence Yun, NAR Chief Economist