Alarmingly large drops in pending home sales and existing home sales. Analysts forecast price declines for 2023, and the sector’s downturn will significantly impact the US economy.

Authors: Mario Becedas and Vicente Nieves

Source: El Economista

The US real estate market is increasingly approaching a forced landing. Although experts rule out a crash similar to that of 2007-2008, some leading indicators suggest a significant downturn in housing prices and overall real estate activity, which could exacerbate the anticipated recession the US may face in the coming quarters. The Pending Home Sales Index (PHSI) plummeted by 4.6% in October, with a nearly 37% year-on-year drop in pending transactions, marking the largest decline in the history of this index.

This indicator is closely monitored by investors and economists because it often anticipates movements in the real estate market regarding prices and sector activity. According to the National Association of Realtors (NAR), which publishes this index, the Pending Home Sales Index is a leading indicator for the housing sector, based on pending sales of existing properties.

A sale is considered pending when the contract has been signed, but the transaction has not yet been completed. The sale is usually finalized within one or two months from the signing. A significant drop in this indicator indicates that the buying and selling activity is starting to slow down for some reason.

Fitch Ratings points out in a report released this week that “demand in the US will continue to decrease going into 2023, further eroding home prices. Materially higher mortgage costs (with average payments rising over 50% since 2021) will impact first-time buyers and those looking to upgrade their properties.” “Real estate investors have begun to step back and will remain on the sidelines until 2023,” they assert.

A Flood of Negative Data

The flood of data released each month about the US real estate market reflects the same trend. Among the numerous negative indicators, the October existing home sales data, released in mid-November, stands out. This statistic from NAR is crucial for studying the market because existing home sales – data recorded when a contract is closed – represent about 90% of US homes.

In October, existing home sales fell for the ninth consecutive month. Contract closures decreased by 5.9% to a seasonally adjusted annual rate of 4.43 million, the slowest pace since May 2020. Sales of single-family homes dropped by 6.4% from the previous month, reaching the lowest level since May 2020. Year-on-year, the decline is even more alarming: existing home sales fell by 28.4%, and single-family home sales dropped by 28.2%.

This aligns with a model developed by Apollo IM analysts, who project a nearly 24% drop in sales of existing single-family homes since the Federal Reserve started raising rates again this spring. It is the most aggressive and rapid decline in sales since the Fed’s first rate hike of this cycle, according to historical records collected by the management firm, dating back to the 1970s.

Home sales have fallen every month since February, marking the longest streak of declines in data going back to 1999 for NAR. The Fed’s efforts to combat inflation through interest rates have led to a rapid rise in loan costs, crushing demand and putting homeownership out of reach for many families.

“More potential homebuyers were excluded from obtaining a mortgage in October as mortgage rates increased,” said Lawrence Yun, Chief Economist at NAR, upon the release of the data. “Mortgage rates have decreased since peaking in mid-November, so home sales may be close to bottoming out in the current real estate cycle.” Mortgage rates have recently fallen below 7%, but they remain extremely high, and analysts have little optimism. It is worth noting that at the beginning of 2022, these rates (typically referencing the 30-year fixed-rate mortgage) were around 3%.

“Existing home sales fell 5.9% month-over-month to 4.43 million annualized in October, a 32% decline from the peak earlier in the year. The drop in sales reflects a worsening in purchasing conditions, as the rise in mortgage rates has pushed affordability to its worst level since 1985,” summarized Sam Hall from Capital Economics, after seeing the October figures.

Under Pressure in 2023

“We expect home sales to remain under pressure for most of 2023, weighed down by reduced affordability, recession, and still limited supply,” forecasted Nancy Vanden Houten, Chief US Economist at Oxford Economics, following the existing home sales data. “We anticipate annual home price growth will turn negative in 2023, reaching a low of -5% year-on-year in the second quarter,” she added.

Fitch Ratings also predicts a nominal 5% drop in US home prices. This means that prices will decrease by 5% regardless of inflation’s strength, which in real terms will represent an even greater decline in property prices. “With a divided US Congress, any intervention to improve housing affordability would need to come from banks, as significant government support is unlikely. Regions that experienced the greatest price gains since the pandemic are expected to suffer more severe declines than the national average,” these experts maintain.

Andreas Steno Larsen, former Chief Strategist at Nordea, believes that “according to their models, a 15-20% decrease in the residential price index maintained by the Bank for International Settlements (BIS) seems likely.” The BIS has one of the longest and most comprehensive housing price histories, based on data from central banks, private institutions, and national statistical institutes. According to this database, real annual housing prices (adjusted for inflation) had already fallen in the second quarter of 2022 in countries like Sweden, Finland, Denmark, and Spain, but remained positive in the US.

For Hall from Capital Economics, the rise in mortgage rates to 7% in October indicates that sales have further room to decline: “The rise in interest rates led to another drop in mortgage applications for home purchases in October, which usually precede existing home sales by a month. Based on this, we expect existing home sales to fall to around 4.2 million annualized by the end of 2022.”

Sam Hall (Capital Economics): “Home prices will need to continue falling over the next year for buying a home to be a realistic option for most households.”

“Looking ahead, affordability constraints will continue to weigh on sales next year, and buyers will also face other limitations. Given our forecast for a sustained decline in home prices, we expect banks to maintain restrictive credit conditions, which will keep many buyers out of the market. And with the economy heading toward a mild recession, buyers will be cautious about purchasing a home,” Hall added, emphasizing that “2023 will be the weakest year for existing home sales since 2011.”

A few days later, the widely watched Case-Shiller home price index for September was released. Although it was somewhat delayed, the numbers reinforced the evidence. After seasonal adjustment, the Case-Shiller composite index showed a 0.8% month-over-month price drop in September. On a year-on-year basis, this means growth fell to 10.6% from 13.0% in August. This is considering that Case-Shiller is an average of data from the last three months, so this release does not reflect the full impact of mortgage rates rising above 7%.

“Home prices will need to continue falling over the next year for buying a home to be a realistic option for most households. Given this, it is likely that banks will restrict the availability of higher loan-to-value products to reduce the risk of negative equity. This will place further downward pressure on purchasing power and prices,” Hall stated in another recent analysis. The expert expects the annual home price growth rate to turn negative early in 2023 and for prices to fall 8% from peak to trough.

Impact on the Economy

The downturn in the real estate sector could weigh on the American economy. Residential investment will drag on US GDP, while falling home prices will affect household spending decisions through the wealth effect. The decline in housing, the primary asset for households, usually triggers a reduction in family consumption, as families tend to save to ‘compensate’ for the drop in their asset’s value. As noted by Steno Larsen, referencing data from the National Association of Home Builders (NAHB), housing represents between 15% and 18% of the country’s GDP, making it “the main driver of the US economy.”

Allianz expects a -6.3% drop this year and another -6.4% next year, but this would only reduce annual GDP growth by 0.2 percentage points. However, real estate services have a much more potent effect. A reduction in this activity and falling prices could notably reduce the added value generated by this sector in the economy. According to Allianz’s calculations, the housing market correction could cut up to 1.7 percentage points from GDP by early 2024, increasing the risk of a more prolonged recession.

“The weakness in economic prospects also points to further declines in home prices. As rising interest rates slow economic activity and reduce employment, households will be reluctant to part with their savings and make a major purchase like a home. Negative expectations about home prices will also persuade many to delay purchasing,” Hall from Capital Economics noted.

Recently, an NAHB indicator has been used to confirm the uncertain medium-term future of the US economy. Its Housing Market Index (HMI) had a recent reading of 33 points (below 50 indicates contraction territory). Experts are concerned about the low confidence among builders, given the proven correlation between a sharp drop in the index and an increase in unemployment that typically occurs about 9-12 months later.

Analysts’ forecasts of unemployment rising to the 6-8% range