National Housing Market Update

August 2006

By AngelouEconomics

American's appetite for home buying is finally showing signs of being satisfied. A slowdown in purchases combined with modest price increases and a steadily growing inventory indicates that the red hot housing market of the past few years is cooling.

Home Sales
Fueled by the lowest mortgage rates in 40 years, sales of new and existing homes posted record highs for five straight years. However, after the Federal Reserve continued to tighten monetary policy, raising the overnight lending rate 17 consecutive times since June 2004, all that remains of the housing boom are fading echoes. The consensus among analysts is that national home sales will drop throughout the year, with some predicting a decline as high as 10 percent.

Fewer existing homes were purchased than expected in June, allowing for what could become a buyer's market. The annual pace of purchases dropped from a rate of 6.71 million in May to 6.62 million in June, a decline of 1.4 percent. Long term downward trends are of more concern. June was the third straight month of decline and sales are 9 percent below levels of sales this time last year.

The decline has been widespread, with sales dropping in three of the four regions in the country. Sales dropped 11.3 percent in the Northeast, 7.9 percent in the Midwest, 6 percent in the South, and rose 8.2 percent in the West.

The market for new homes is not faring much better. The annual rate of new home purchases was 1.131 million in June, down 3 percent from the May pace of 1.166. This drop marked the first for new home sales since an 11.5 percent dive in February 2006.

The National Association of Realtors (NAR) is forecasting new and existing home sales to fall 6.7 percent and 6.8 percent, respectively, but believes that could change depending on actions from the Federal Reserve. "The strength of the housing market in future months is dependent on Federal Reserve decisions on interest rates" said Chief Economist David Lereah for NAR.

"If the Fed overshoots and the economy slows too much, some of these local economies will be hurt and that could hurt housing in a significant way,'' Lereah said.

Inventory
At the end of June, there were a record 566,000 new homes on the market, up from 562,000 in May. (New homes include homes that have not started construction, are under construction, and have recently completed construction). This translates into a 6.1 month supply of unsold new homes in June and a 5.9 month supply in May 2006. The inventory of new homes in June of 2005 was 4.3 months of supply, or 30 percent lower than they were this June.

The number of new homes that have completed construction, but have yet to be sold increased to 132,000 in June. Of particular concern to home builders, is that this is the highest inventory since tracking began in December of 1972.

Home Prices
Home prices continued to rise, but not as much as home owners have come to expect. The median price climbed to $231,000 in May 2006 from $229,000 in May 2005, or an increase of only 0.9 percent. This marks the lowest year-over-year gain in median home prices since May 1995.

This is a stark contrast to increases experienced less than a year ago. In October 2005, prices rose to a record 16.8 percent from the previous year due to low inventories and competition among buyers.

"The change in price performance is directly tied to housing inventories - a year ago we had a lean supply of homes and a seller's market, with monthly home sales at an all-time record high," said Lereah.

"Sellers have recognized that they need to be more competitive in their pricing given the rise in housing inventories," he added.

However, the slowing price increases have not made homes any more affordable. The culmination of previous price increases coupled with rising mortgage rates have brought housing affordability to the lowest in over 16 years. From 2000 to 2005 the median home price has risen 58 percent, while the median household income has only risen 10 percent.

So, the cooling housing market that is being experienced across the nation could be explained by an economic correction, bringing housing costs more in line with income levels. Long term economic stability in the housing market will be difficult to maintain if increases in income levels do not keep pace with home prices.

Sources: National Association of Realtors, Bloomberg, CNN