Pending Home Sales Remain Strong

The Mortgage Corner

The Pending Home Sales Index, a forward-looking indicator based on contract signings, declined 1.1 percent to 102.7 in June from 103.8 in May, and is 7.3 percent below June 2013 (110.8), reports the National Association of Realtors. Despite June’s decrease, the index is above 100 – considered an average level of contract activity – for the second consecutive month after failing to reach the mark since November 2013 (100.7).

Lawrence Yun, NAR chief economist, says the housing market is stabilizing, but ongoing challenges are impeding full sales potential. “Activity is notably higher than earlier this year as prices have moderated and inventory levels have improved,” he said. “However, supply shortages still exist in parts of the country, wages are flat, and tight credit conditions are deterring a higher number of potential buyers from fully taking advantage of lower interest rates.”

We also have to look at the newest generation for those potential buyers, the Millennials, or echo boomer children of the baby boomers born after 1980. From ages 18 to 36, they could number as much as 80 million, according to Barron’s Magazine. And this could ultimately generate a huge pent up demand for housing, according to Goldman Sachs analyst Hui Shan.

The fact is more than 35 percent of so-called young adults still live with their parents. It’s in part because of the recession, but also because record numbers have remained in school. Whereas the normal percentage of young adults remaining with parents is about 25 percent, so that extra 10 percent should eventually find their own housing.

"As long as economic recovery and labor market improvements continue, household formation should eventually normalize," Shan writes. "Given the severe damage caused by housing busts to the economy, the process of normalization may take a number of years."

Past history also tells us that new-household formation will pick up, says Shan. "The average household size increased during the first few years of each housing bust, presumably driven by young individuals living with their parents and roommates doubling up to save rent. Over time, the effect reversed itself and average household size retraced the earlier increases, translating into increases in household formation.”

What is normal household formation? It has averaged more than 1 million per year over past decades, but today is somewhere between 350 to 600,000/year, depending on whom you ask. The Harvard Joint Center For Housing Studies predicts it will rise to some 1.2 million annually over the next decade precisely because of Millennials coming of age.

Given the sheer volume of young adults coming of age, the number of households in their 30s should increase by 2.7 million over the coming decade, which should boost demand for new housing. “Ultimately, the large millennial generation will make their presence felt in the owner-occupied market,” says Daniel McCue, research manager of the Joint Center, “just as they already have in the rental market, where demand is strong, rents are rising, construction is robust, and property values increased by double digits for the fourth consecutive year in 2013.”

So despite these headwinds, the NAR’s Yun ultimately expects a slight uptick in pending, and existing-home sales during the second half of the year. Price appreciation has decreased to its slowest pace since March 2012 behind larger increases in inventory, and rents are rising 4 percent annually. So those potential buyers are less likely to experience sticker shock, which makes it more likely that many will choose to buy in order to participate in potential price appreciation, rather than tolerate greater rent increases.

Harlan Green © 2014

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