Every month the National Association of Realtors puts out a report that it calls “Existing Home Sales.” The financial “news” media dutifully reports the story as if it is news, when it is really history. Existing Home Sales is actually a rubber stamp figure from sales data we had a month or two before. It reports the number of real estate closings, not sales. The sales typically happened 4-8 weeks earlier. And they were reported last month in the NAR’s Pending Home Sales report.
Every party to a sale, including the buyer, seller, and realtor, not to mention those in the market looking to buy, considers a property sold when the contract is signed, not when it goes into the public records a couple of months later. The price is established on the date the contract is signed. That’s when the sale sign goes up, and the property comes off the market.
90% of sale contracts typically go to closing. The closing is a formality. The sale is already ancient history by then. Can you imagine looking for the prices of your stocks from 6 or 8 weeks, ago? I mean, who cares?
The NAR and its media handmaidens pretend that “Existing Home Sales” is a meaningful data point on its own. The Wall Street Journal is the worst offender. News Corp. owns both the Journal, Realtor.com, and a company called News America Marketing–“Your marketing objectives are our business.” Put two and two together. These reports on “Existing Home Sales” aren’t news. They are industry PR.
As with virtually every other major data release, this one is on a seasonally adjusted basis (SA). Seasonal adjustment results in an artistic representation of where the number would have been if there were no seasonality. That may or may not be close to the mark. Frequently the number gives a misleading impression that subsequently is revised away They revise the number 7 times after the first release as they attempt to fit their idealized impression of reality to the actual, not seasonally adjusted (NSA) data. It’s published along with the SA data, but everyone (except us) ignores it.
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Many years ago it dawned on me that maybe we would be better off just looking at the actual data. We can compare the rate of change from the current period with the past to discern whether the trend is speeding up, slowing down, stable, or falling. No seasonal adjustment hocus pocus required!
The NAR reported that closings (EHS) fell by 1.8% month to month in June. They calculated the year to year change as a gain of 0.7%.
The month to month actual change in June was an increase of 46,000, or 8.3%. June 2016 was a little better. It saw an increase of 57,000. The average June gain over the prior 10 years was 37,500. This month’s reading was stronger than average, but not as hot as last year.
Their year to year change calculation is just wrong. The actual, unmanipulated monthly number for June was 3.3% greater than June 2016. The NAR committed the cardinal sin of comparing seasonally adjusted numbers for the same month in consecutive years. It resulted in an understatement of the gain. There’s no seasonal difference between June of one year and another, so what they’ve done is to compound the seasonal adjustment error inherent in each month. The actual year to year gain of 3.3% wasn’t great. It just wasn’t as slow as the NAR reported.
The number did reveal a problem however. There were more closings than there should have been based on the number of contracts in the previous 2 months. The time between contract and closing is usually 1-2 months. Some take a little longer, and some cash sales happen more quickly. But most sales are closed within 60 days. The number of closings should be a bit less than the average number of contracts per month over the last 2 months.
Typically, around 90% of contracts make it to closing. If the percentage is lower, it means that credit standards are unusually tight. That’s what happened at the bottom of the market in 2011-12 after the crash. If the percentage is higher, it means that credit standards are unusually easy, and/or that sales are being rushed to closing to beat expected rising mortgage rates or tightening credit standards. That’s where we are today.
The average number of closings for April and May was 590,000. 601,000 sales closed in June. That’s a ratio of 102%. It means that buyers, sellers, and lenders are not only closing sales that would not meet normal underwriting standards, they are accelerating sales to close more quickly than normal. It’s a hallmark of an irrational, bubbly market.
I have created an index to depict this visually. It is the 12 month moving average of the ratio of monthly sales contracts to the subsequent closings. It’s now approaching 95%, the highest level since the Great Housing Bubble rolled over in 2007. The 1 month reading hit 109% back in March. That was the highest it has been since the top of the bubble in 2006. Note also that contracts fell sharply in April. Yet closings rose in June. This is another sign that they’re pushing everything but the kitchen sink to the closing table.
This data shows that the housing market is extremely frothy. Buyers are being approved who whose credit and income would normally not qualify them to purchase. Appraisal values are being pushed to and beyond the limits of reasonableness. We have seen this act before. Mortgage fraud, particularly in subprime, was rampant during the bubble. The data says that it is happening again, merely a dozen years later.
It’s not normal for a consistent 95% of sales to close. Once the ratio gets above 92%, it’s getting into nosebleed territory. This is a buying panic. There’s a panic to get deals closed.
It will ultimately lead to a demand vacuum. We can’t say precisely when, but we know that buyers are being squeezed. The demand pool is being decimated. Willing, financially qualified buyers will become fewer and farther between as mortgage rates rise and home prices inflate.
And inflating they are. The NAR’s median home price is calculated from data collected from a broad sampling of MLS services across the US in June. I was in the real estate business for many years as both a Realtor, mortgage broker, and commercial real estate appraiser. I was a foot soldier in helping to collect this data, and I used it in my loan and appraisal work for many years. It’s the best data on home prices that there is. Unlike Case Shiller and the FHFA indexes it is not massaged, lagged, smoothed to the point of uselessness. It’s as broad, deep, and as close to real time as aggregated home price data can be.
And it shows steady, brutal inflation. Economists, the media, and even homeowners call it something else, usually “appreciation” or “growth.” But make no mistake. In spite of whatever euphemisms are used to name it, this is inflation in its most essential form. The excess money created by the Fed and other major central banks in the world has to go somewhere, and one of the places has been US housing.
The year to year inflation rate in June was 6.5%. This is not a flash in the pan. The annual inflation rate has been between 5.5% and 7.5% since July 2016. The housing inflation rate hasn’t been below 4.3% since 2012. When economists say that inflation is too low, that’s only because they ignore housing. Home prices are not included in CPI or the Fed’s favorite measure of inflation, the PCE. Housing inflation is conveniently ignored.
The median sale price for existing homes is now $263,800. Based on typical mortgage terms today with a 30 year fixed rate mortgage at 3.9%, the total monthly payment on a 90% mortgage would be approximately $1,600, including principle, interest, taxes, and insurance (PITI). At a standard qualifying ratio of 28% of household income for the PITI, the required annual income would be approximately $68,500.
Median household income in the US in 2015 was $56,500. Let’s be generous and assume that it has increased by 5% in the two years since then. Median household income today would then be around $59,300. That’s still a long way from the $68,500 that would be needed to qualify for the median priced home. And that’s assuming that the buyer has enough cash for a down payment of more than $26,000, plus several thousand in closing costs.
Whatever the number of buyers who qualify to purchase a home is today, the numbers will only shrink as prices continue to inflate at double or triple the rate of household income. If mortgage rates rise, as I expect later this year and beyond, demand for homes will evaporate.
Demand would diminish from inflation alone even if rates were stable. An increase in mortgage rates would push demand off the cliff. A demand collapse in 2005-06 led the onset of the housing price crash by about a year as the Great Housing Bubble rolled. No doubt a collapse in sales volume this time around will also precede a price collapse.
The Fed has always believed that it could engineer a soft landing in every monetary tightening cycle. Most of the time that wish hasn’t been fulfilled, and conditions have devolved into a crisis before a bottom was reached.
By the time you read this, the Fed may have already made an announcement as to when it will begin this round of tightening. When the Fed begins to shrink its balance sheet and remove cash from the banking system, US Treasury yields will rise. Mortgage rates are tied to those yields. They too will rise. The housing market will contract far more quickly than the Fed expects. I doubt that the Fed will be able to put that genie back in the bottle.
Housing development and related stocks have not begun to reflect what probably lies ahead. If you own them, sell them. If this isn’t the top, we’re very close. Looking ahead, I’ll want to short them once they have broken the first key support level and had a reaction rally. For those of us who like leverage, I would consider put purchases at the first sign of price decline. When buying options, it is pointless, even counterproductive, to be early. You can burn through a lot of capital being “right” on the theory but too early on the practical timing.
Lee’s work combines in depth monetary and liquidity analysis with technical analysis of market price movements. He first reported in 2002 that Fed actions were driving US stock prices. He has tracked and reported on that relationship for his subscribers ever since. He has been reporting on gold prices and precious metals stock prices since 2000. He called the secular trend gold bottom in 2001. Follow Lee’s weekly market timing reports on gold, and trading recommendations on mining stocks and ETFs, in the Wall Street Examiner Pro Trader Precious Metals Updates. Try the service risk free for 90 days.
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