Bank of America is ringing the proverbial bell on the US real estate market, saying existing home sales have peaked, reflecting declining affordability, greater price reductions and deteriorating housing sentiment. In the latest weekly report from chief economist Michelle Meyer, the bank warned that “the housing market is no longer a tailwind for the economy but rather a headwind.”
“Call your realtor,” the BofA note proclaimed: “We are calling it: existing home sales have peaked.”
BofA’s economists believe the peak was seen when existing home sales hit 5.72 million, back in November 2017. From this point on, sales should trend sideways, as this moment in time is comparable to the rate the economy witnessed in the early 2000s before the bubble inflated.
And while BofA believes existing home sales have plateaued, they do not think the same for new home sales. The reason: new home sales have lagged existing in this “economic recovery” – leaving home builders some room to flood the market with new single-family units before a turning point in the entire real estate market is realized.
The deterioration in affordability can mostly explain the peak in existing home sales. This is due to the Federal Reserve reinflating real estate prices back to levels last seen since before the 2008 crash. The National Association of Realtors (NAR) affordability index prints 138.8, the lowest since August 2008.
Chart 1 (below) shows there is a leading relationship between the trend in affordability and in home sales — a simple regression suggests the lead is about three months. In major cities, affordability continues to be a significant problem for many Americans amid a rising interest rate environment and elevated home prices, existing home sales should remain under pressure for the foreseeable future.
Chart 2 (above right) indicates that the share of properties with price discounts is on the rise, suggesting that sellers are unloading into weakening demand. The data from Zillow reveals that 15 percent of listings have price reductions, the highest since mid-2013 when home sales tumbled last.
The University of Michigan survey (Chart 3 below) reveals a worsening mood in the perception of buying conditions for homes. Respondents noted that home prices have become too high while rates have become restrictive.
BofA said that existing home sales were quick to recover post-crisis given motivated sellers – the lenders who were sitting with millions of distressed properties.
Distressed properties made up between 30 and 40 percent of sales in the early stages of the recovery.
Home prices were discounted until they reached the market clearing price and buyers entered.
The recovery for new homes sales began one year after existing, as homebuilders stayed idol waiting for the dust to settle.
“We are now looking at a market where existing home sales have returned to a solid pace but new home sales are still below normal levels. We think that builders will continue to selectively add inventory in markets where there is demand, allowing new home sales to glide higher. Ultimately we think new home sales will peak around 1mn saar based on the historical relationship between existing and new home sales,” said BofA.
BofA asks the difficult question: If existing home sales have peaked, does it mean the rate of growth of home prices will as well?
Their answer: In the last cycle, existing home sales peaked at 6.26mn saar on September 2005, coinciding with peak home price growth of 14.4 percent the same month (Chart 5). The pre-boom historical data are generally supportive as well, as are the recent data-single family existing home sales peaked at 4.9mn saar in March this year, as did home price appreciation at 6.5 percent. The result, well, existing home sales are pressured by declining affordability, home price growth should slow from here. BofA said a contraction in home prices seems unlikely at the moment, however, if demand is not stoked soon that can all change.
While BofA makes clear the housing market is starting to stall, the Federal Reserve is conducting quantitative tightening and rapidly increasing interest rates to get ahead of the next recession. In other words, liquidity is being removed from the system and the cost of borrowing is headed higher – an environment that is not friendly to real estate, and could be the key factor explaining the weakness in housing.
Which brings up another important question: while financial assets continue to rise, these have largely benefited the Top 10% of the population; meanwhile the bulk of the US middle class net worth has traditionally been allocated to such fixed assets as real estate. And if that is now rolling over, what is the outlook for the US consumer, which remains the dynamo behind the US economy?
There is another, potentially more troubling observation. According to TS Lombard, the current period is now only the third time in US history – after 1968 and 1999 – in which equities have made up a larger percentage of net worth than real estate.
While this may be good news for holders of stocks, it may not last: as TS Lombard observes, sharp bear markets followed shortly after 1968 and even sooner after 1999. And with housing peaking – if BofA is correct – share prices remain the only driver behind continued economic growth, prompting TSL to conclude that “the US economy can not afford a bear market.”