It's frustrating to see economists or financial analysts attempting to apply the same financial ratios to the housing market. The P/E ratio that works on stocks simply doesn't make sense on someone's residence. It's even more frustrating to hear experts stating, as-a-matter-of-factly, that higher interest rate means lower home price. If that's true than housing prices should be positively correlated with the bond prices. But, that's just not the case. It also doesn't make sense for the interest rate to be so commonly used as though that's the one most significant indicator for the housing market. But, more on the interest rate later.
Here's taking a different look at the housing market.
Real estate market is regional. Real properties don't trade through the same national or international exchanges. Socioeconomic shifts may impact one region negatively while the others positively. Therefore, perhaps the best approach is to analyze the regional markets first, especially the major regions that represent a large slice of the national real estate pie.
Let me start with the East Bay of the San Francisco Bay Area region. According to the Census Bureau, California is the most populous state. These 2 counties in my analysis are two of the 10 most populous counties in California. While this does not represent the entire housing market, the mere size of this metropolitan area may help shed some light on the well beings of the housing market.
I only use 3 of the indicators in this analysis. If this turns out to be something of interest to the readers, I'll exhibit other useful indicators in my future housing market reports.
The Sales
This chart compares the number of pending sales and the number of properties sold. As you can see, there are 2 different time scales, or X axes. The time scale on the top is for the pending sales (blue letters), and bottom axis is the time scale for the sold properties (red letters). The sold properties lag behind the pending sales by 30 days. That’s the normal amount of time it takes for all the inspections, disclosures, loan applications, and escrow to complete. Upon completion of this process, the property is then changed from pending to sold status. The important thing here is that NOT all pending sales lead to successful closing.
Chart 1
When more sales fail to close, it creates gaps between these 2 lines. There are many reasons for an escrow to fall through, but it’s primarily due to problems with buyer’s financing. This is even more so in a hot real estate market. A hot housing market is a seller’s market, which means motivated buyers would generally accept sellers’ terms and sellers’ property conditions. And, unless there are irresolvable problems with buyer’s financing, most escrows do go through.
In a healthy housing market that’s backed by a healthy economy and strong job growth, the number of pending sales usually stays close to the number of sold properties reported 30 days later. The recent market action on Chart 1 shows otherwise. The number of final sales (red line) gaps below the number of pending sales (blue line) consistently since March indicates the fundamental weakness of our housing market.
The Sentiment
Let’s now take a look at this recently updated MLS Membership chart. MLS is the Multiple Listing Service that real estate agents use to upload their listings for marketing. That’s the medium through which majority of the properties are sold. The property database that you searched on the Internet came collectively from these local services.
Chart 2
Chart 2 shows an uptrend that forms consecutive higher highs since November 2004. That’s an impressive and strong uptrend. And, as though that’s not impressive enough, it had also set all-time MLS membership records in each of the last three months – March, April, & May. The record is now at 4,731.
This extreme euphoric sentiment toward real estate business stems from the perception that real estate is where the money is. And, that motivates more and more people to obtain real estate licenses and to join the MLS system. Unfortunately, the perception, in this instance, is not reality. This is what makes this MLS membership data a legitimate Sentiment Indicator.
From a contrarian point of view, the topping process of this sentiment indicator represents the beginning of the end of the real estate boom. Usually, the commencement of the market deterioration is not visible to the public or even to most real estate agents. The divergence between the MLS membership data and the Number of Units Sold (Chart 3) demonstrates the validity of this contrarian perspective.
Chat 3 shows the total number of units sold in May this year actually declined 7.18% from May of last year – from 3,328 units to 3,089 units.
Chart 3
Last May, there were 4,205 MLS participants (refer to Chart 2). This May, the new record was 4,731 – an increase of 12.51%. Last May, each MLS member sold 0.79 units per month (3328/4205). This May each MLS member sold only 0.65 units per month (3089/4731). The number of units sold per agent dropped 17.50% from last year. And yet, there are more MLS participants than ever. Intriguing, isn’t it?!
Now that we’ve established the MLS membership data’s legitimacy as a contrarian sentiment indicator, all we’d have to do is to monitor whether it begins a bearish reversal pattern of forming lower highs.
From these indicators and the others that I'm using, I can see visible weaknesses in the making. But, I've yet to see any of my indicators signaling this so-called "bursting of the housing bubble". We'll know if and when this happens from the study of the language of the market.
The Interest Rate
So far, I’ve not based any of my analysis on the interest rates, but I’m certain you could see the underlying housing market weaknesses addressed by the above referenced technical and fundamental points.
Here’s a table showing some of the recent years with the double-digit mortgage interest rates happened to be the years with the double-digit YTY median price growth, namely 1986, 1988, and 1989. And, 1993, the year with one of the lowest interest rates happened to have a negative growth in housing price. Who came up with this idea that higher interest rates mean lower home prices?
I’m sure we could get into extensive debate, or discussion, about this phenomenon, but that’s beyond the scope and the relevance of this article. The purpose here is simply to point out that while interest rate is an important factor, it’s not the most important factor that affects the housing market.
Interest rate’s influence on the housing market is only relative to the other more relevant factors such as population migration, employment, demographic shifts, real incomes, and the overall economy, etc. If the economy and the real incomes are growing and home buyers can financially afford the payments, why would higher interest rates even matter?
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