Home Sales: Up, Down or Sideways From Here

By Annaly Capital Management

Existing home sales can’t go to zero, can they? They clocked in at 3.83 million on a seasonally adjusted annualized basis in July, down 27% from the prior year, half of the 2005 peak of 7.25 million and the lowest since the National Association of Realtors started keeping records in 1999. The reason given most often for the steep drop is the end of the $8,000 tax credit that pulled future sales back to the spring. We understand this line of reasoning; we made the same one when we watched the pullback in auto sales after the end of the Cash-for-Clunkers program. The distorting effects of government support for any market will be made manifest when that support is removed.

The new question for the housing market—if not the whole US economy—is where we go from here. In the graph below we lagged existing home sales by eight months so that the top in the market prior to the expiration of government support, April 2010, coincides with the Cash-for-Clunkers driven top in new car sales, November 2009. (So forgive our graphmaking…the x-axis directly corresponds to car sales.)

Cars are not homes. The product is different: Cars have more limited life spans, lower price points, no down payment requirements and they can be junked or left to rot in front yards at their depreciated value. And the market is different: Carmakers can calibrate production more precisely, and a leased car is counted as a sale. So the experience of car sales shouldn’t necessarily be a guide for home sales. That said, both typically require financing, are economically sensitive and a barometer of consumer confidence. We certainly observed that each market will respond to government stimulus and will behave similarly once the government support is removed. Thus, if we want to use the experience of the car market as a template for home sales, then eight months from now we should expect to see existing home sales still at cyclical lows but gradually improving.

But what this very simplistic analysis fails to take into account are the prices at which those home sales may occur. The housing market is dealing with a huge supply problem right now. The number of existing homes for sale has stayed rather flat at 4 million, but based on the latest sales figure, the inventory now stands at a record 12.5 months of supply. But the graph below, courtesy of Ivy Zelman and her eponymous Zelman & Associates, tells an even worse story. After factoring in the growing amounts of homes in the shadow pipeline supply of 90-day delinquent homes and homes in the foreclosure process, there are over 26 months of supply. Based on the graph below, unless we hear about a big uptick in bulldozer sales, the experience of the car market may also be accompanied by a downdraft in home prices.

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