A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

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Age: 26 Occupation: Private Equity

Saturday, March 24, 2007

Home-Sales Surge May Not Reflect Subprime Woes

In examining the NAR's existing home sales report from Friday, March 23, the real big news, in my opinion (and how the headlines should read), is the 7.6% slide in median home prices since July 2006, when the median price was $230,000. That's $18,000 in "equity" that has gone up in smoke. (Just assuming, for simplicity, that the "mix" of homes sold in the data is little changed - we're talking about a set of large numbers, so this tends to be so).

If you bought then, with no money down, and assuming closing costs of $3,000, you could be $21,000 in the hole right now. If you factor in real estate placement fees of 6% (another $12,700), you are looking at a median loss of $33,720 on the sale of your "median" home right now! OUCH! That's a tragedy on a massive scale. For the 605,000 who bought then, that translates to an approximate loss of $12 billion in "equity" (without consideration for real estate fees). For all who bought in 2006, the number could be as high as $75 billion... OUCH (again)!

Courtesy of the Wall Street Journal (After a Few Rants)...

I plan on keeping this blog weekly, but people have to see this article... It's important that we have full knowledge of the actual data on housing, especially given the provider (NAR - National Association of REALTORS) ) ... and especially when seasonal adjustments and other manipulations come into effect, such as the NAR's phantom downward revisions of year-ago data (curious, because usually these revisions occur within one or two months... seems convenient that, when they wanted to keep the train rolling, prices were "higher" and now, at damage control time, "oops, they weren't really that high after all!").

I'm not anti-home ownership... I think it's a great thing when you can get even a moderately reasonable price. However, prices aren't reasonable at the present (by any sane measure), and as such, I'm against making a first-time home purchase in the Northeast and the West at this time. (I will provide a post on the detailed calculations behind it in the future, but suffice it to say that, given the differences between prices and rents, if they persist, then renters are better off renting for the rest of their lives). As I've said on this blog before, NO INVESTMENT IS GOOD WITHOUT FIRST CONSIDERING THE PRICE. That's just common sense. There are plenty of great assets out there, but paying too much can turn a great asset into an atrocious investment (see: stock market bubble).

What I am against is the NAR... One should always be somewhat suspicious of any information received from a group whose motives are driven not by public service, but by PROFIT OFF OF YOU! No, they don't lie, but they do want to paint as rosy a picture as possible (it all depends on what data you throw out, and what you keep - learned that in Investment Banking, where EVERY client we visited was undervalued compared to their comps - how do you think we did that?). A REALTOR has a vested interest in keeping the overpriced party going. They would much rather get 6% of $300,000 than 6% of $150,000 (Remember that's YOUR MONEY they are taking, and, in a $300,000 house, that's an extra $18,000 in appreciation and pay-down of debt principal, on top of your closing costs, that you have to make up to break even).

As a primer, the true rate of home sales was 4.6 million annually in February... The extra two million is a seasonal adjustment that is determined by a statistician... a very subjective number... we'll learn more in the coming months, when the "seasonal" factors go away.

And now, the article as promised...

Home-Sales Surge May Not Reflect Subprime Woes

March 24, 2007

Sales of previously occupied homes rose unexpectedly last month, but economists said the increase was partly driven by unseasonably warm weather and didn't fully reflect the current turmoil in the subprime mortgage market.

The recent surge in defaults on subprime mortgages, those for people with weaker credit records, has forced lenders to tighten their standards. That is expected to eliminate many potential home buyers, damping sales in the months ahead.

The National Association of Realtors said sales of existing homes increased 3.9% in February from a month earlier to a seasonally adjusted annual rate of 6.69 million units. That sales rate was 3.6% below the year-earlier level.

[Prices Slide, Sales Climb]

The latest data reflect completions of home sales in February that resulted from purchase agreements that were mostly signed in December and early January, when unusually warm weather in the Northeast may have enticed more people to shop for homes. The Northeast led the nation with a 14.2% surge in sales in February from a month earlier, while sales increased 1.6% in the South and 3.9% in the Midwest. They were unchanged in the West. Economists also cautioned the unusually warm weather may have confounded seasonal adjustments meant to compensate for lower activity in winter.

"This was purely a fluke number," said Joshua Shapiro, chief U.S. economist at consultancy MFR Inc. "You can bet dollars to doughnuts that next month this number is going to come right back down."

The national median home price dropped to $212,800, a 1.3% decline from a year earlier. Without a downward revision in the year-earlier median, the decline would have been 2.1%, said Thomas Lawler, a housing economist in Vienna, Va. Mr. Lawler said it was the second month in a row that the NAR has revised the year-earlier median price downward. NAR chief economist David Lereah said such revisions are automated and "happen all the time."

Some analysts say price cuts and low interest rates are bringing buyers back into the market, which helped boost sales in February and in the previous month. But the outlook for the housing recovery is clouded by the meltdown in the subprime mortgage market that is beginning to stymie many borrowers with poor credit from obtaining financing.

Mr. Lereah predicted Friday that credit tightening will reduce home sales by 100,000 to 250,000 annually over the next two years. Most economists say this winnowing of home buyers is only now emerging and could drive down home sales in the coming months.

"Our view had been that sales were going to turn around in middle of '07," said Patrick Newport, economist at consultancy Global Insight. "But I don't think that is going to happen because a segment of the home-buying market is not going to be able to borrow money."

The inventory of homes for sale rose 5.9% to 3.75 million at the end of February, which represents a 6.7-month supply at the current sales pace. That's down from a 7.4-month supply in October.

Economists say the number of homes on the market typically increases in February as the peak spring selling season kicks off. In some markets, rising foreclosures threaten to worsen the glut of homes offered for sale. Credit Suisse analyst Ivy Zelman estimates that foreclosures could add as much as 20% to the current inventory of existing homes.


Ghu206 said...

Why doesn't anybody explain this to us? Unbelievable.

eternitus said...

That's why I write... Thanks for reading. I'm trying to make sure everybody gets the facts correctly.

Dr.Funkenberry said...

It's my understanding that this number is flawed for yet another reason and that is NAR does not subtract cancelled contracts from this number, making it useless to use to get a picture of the current economic activity.

Anonymous said...

The NAR monthly spin is not worth wasting time with. For good graphs showing actual YOY numbers for sales, median price and inventory you can check here


eternitus said...

Dr. Funkenberry, I didn't even realize that.

Hat tip to you... I'm always up for learning something new. Its a shame that compliant "journalists" post these numbers without explaining the caveats associated with them.

Many also give limited exposure to economists (who know this) who aren't on the housing industry's payroll.

dxm113 said...

Of course those with vested interests in the real estate game don't want others to know what's going on. They want everybody to believe that a home purchase is their golden ticket, and that home prices will always keep appreciating. They will be the first to tell you that your home is an asset, a great investment . . . whose asset? The mortgage lender's?

MyTwoCents said...


For some good NOVA information, you may want to check out: http://www.nvar.com/market/history.lasso

This shows the Sales Price, Qty. Sold, and Volume for NOVA back to 1975. I plotted this data and you can very clearly see the ebb and flow of the last peak during the late 80's early 90's through to today. The graph goes exponential once you hit 2001.

I did a least squares fit (using Excel) for the years 1975-2005 and found that as of 2005, the market was approximately 49% above a long term trend line. I then looked at 1980-2000 and found prices to be 81% above that shorter trend period. Basically, I discounted the recent run-up to try and determine what the long term growth really looks like. I knew I had a peak around '91 that had a solid 10 years on either side to work with and I found that the latter least squares fit really fit most of the older data much better.

Any how, the reason I share this is I had been using it as a reasonable basis for where prices should be long term. I expect that prices will come pretty close to reapproaching this long term trend line before the cycle repeats. Though likely, prices will stagnate and level off until buyers (via wage inflation) catch up. This is what appears to have happened from '91-'98.

My $0.02.

eternitus said...

Thanks for the power post, mytwocents! I really do love regression analysis... can be a powerful tool. Visualization of data is also an excellent way to spot trends...

My calculations (which will be the subject of my next post - thanks for the idea) suggest a 40-50% overvaluation based on interest rate and income fundamentals. I concur with your general thesis.

I'm not knit-picking - but I like to spread a little knowledge when I can...

A least-squares fit is a good way to get a quick fix on trends in data... however, when you use OLS, you first need to make sure the underlying trend is linear (prices compound - so price trends actually are exponential)... A good way to combat this is to benchmark values against incomes or inflation, or do a % change in price vs. % change in income.

There are other concerns with OLS regarding time-series data (autocorrelation, somewhat misleading r-squared values), but again, those can be mitigated in a number of ways...

But again, none of the above change the fact that your answer is correct. Good work and thanks for the pricing data!