Demand Versus Buyer Hesitation

by Lawrence Yun, NAR Chief Economist

U.S. Economic Outlook

Any boost to buyer confidence will have a significant impact in reviving the housing market and in lifting the economy.
The Forecast: Charts
Anticipated lower home prices are holding back many people from buying a home now.
The weakness in the U.S. economy in the fourth quarter of 2007 was affirmed by very soft job figures for December. Only 18,000 net new payroll jobs were added during the month compared to 119,000 monthly job gains for the rest of 2007 and 189,000 (monthly) in 2006. The unemployment rate rose to 5.0%, its highest level in two years, after having treaded at around 4.5% in the first half of 2007.

Housing Market Fallout
Not surprisingly, the housing market fallout contributed heavily to the weak overall conditions. Residential construction and related contractor jobs fell by 28,500 during the month and are now lower by 291,000 from their peak employment level nearly two years ago. The commercial real estate market appears to be topping out as 16,800 jobs were cut in December. NAR’s commercial leading indicator had pointed to a modest slide in the commercial sector back in November. Still, the commercial market has held on much better than the residential sector. The latest job figures in commercial real estate showed 334,000 more jobs currently than from a cyclical low in February 2004. The multiyear job gains reflect a strong rise in commercial real estate spending. Spending on non-residential private construction totaled $483 billion (annualized) as of the third quarter 2007; that is considerably higher than the $277 billion and $298 billion recorded in 2003 and 2004, respectively.

Current housing market conditions remain weak. Existing-home sales have been right at or near 5 million for the past three months, possibly hinting at stabilization and a formation of a bottom. But the current annualized sales pace would only match the 1998 annual figures (10 years ago) and are down 20% from a year ago and down 30% from the peak year of 2005. The current level of activity is far below that of even the pre-boom year of 2001.

New home construction and new home sales have contracted even more. Recent new single-family housing starts have been in the range of 800,000 to 900,000 and new home sales have fallen well below 700,000. Those figures are down by roughly 50% from their respective peak annual figures in 2005. Though the cutbacks are hampering the economy, they have brought down housing inventory. Housing supply is one of those figures that is usually not in the headlines, but new home inventory has been trending down for more than a year. (The months’ supply has not fallen because the sales pace has weakened.) There were 570,000 new homes for sale in the summer of 2007. There were 509,000 at the end of November.

At the national level, home prices continue to move lower. The most timely and broadest measure from NAR based on multiple listing service information indicates home prices are 3.3% below a year ago.

The near-term forecast continues to point toward weak conditions. Housing permits continue to fall, indicating a further decline in new home construction and new home sales. NAR’s pending home sales index also remains soft, though it has been essentially flat for the past three months.

Will housing demand return solidly by spring of 2008 – even after we account for the normal higher sales activity in the spring months? It is a bit uncertain. On the one hand we have a sizable pent-up demand. On the other hand, we have buyers waiting it out, hoping for lower home prices and lower interest rates.

Pent-Up Demand
The pent-up demand is indeed sizable once we run through the tapes. Job and income gains have risen solidly over the past two years – interesting when at the same time home sales have been falling. Net job gains have increased by 4.3 million according to both company payroll data and household survey data. U.S. aggregate personal income has risen by $1.4 trillion over the past two years. Such job gains should have translated into about 2 million additional homeowners, yet the actual rise over the two-year span was only 600,000. Over the same time period, housing affordability has actually improved with incomes rising, home prices falling, and conforming mortgage rates at near historic lows, yet … a very slow rate of net new homeowners.
Furthermore, household formation has mysteriously slowed. With normal population and job increases, household formation typically expands by 1.2 million to 1.5 million per year. The latest Census data points to only 650,000 net new households formed in 2007. Many people have evidently doubled-up with additional roommates or have moved back with parents and family members.

But buyers are hesitant. Why? Anticipated lower home prices are holding back many people from buying a home now. Foreclosures will continue to rise in 2008. There are many research reports and media reports (irrespective of validity) pointing to further price declines. Anticipated lower interest rates are also holding back many potential buyers. It is widely believe that the Federal Reserve will be cutting rates in the next two or three meetings. Though there is no direct relationship between a Fed rate cut and mortgage rate changes, many consumers perceive that mortgage rates will fall with the later Fed rate cut. Given this perception, it would be wise to make a one-time large rate cut rather than a series of small rate cuts in order to end the delay in home buying. Since the Fed Funds rate is likely to be at 3.5% by late spring, why not just cut it to that level (from its current 4.25%) at the next FOMC meeting?

Though pent-up demand clearly exists, it is still tricky to anticipate when a meaningful recovery will take place. I do not foresee any major existing-home sales declines from this point onwards, but sales could remain at their current soft pace for a while. Will it be spring or summer or fall when we will see a notable pick-up in home sales? Difficult to say, but it will happen in 2008.