If You’re Not Scared of This Real Estate Misnomer, You Should Be…

The National Association of Realtors (NAR) reports both current data and lagging data.

But if you look only at the old data, it may cause you to make bad real estate investment decisions.

With years of professional experience in the trenches of the real estate finance industry, and as an erstwhile homebuyer and seller, I know that the numbers reported by the NAR matter. But some of its data is better than other.

Some of the NAR data is stale, old data that reflects what was happening in the market months ago. That may not matter during a long stable trend. But when the trend is changing, like now, being a few months behind the curve can make a big difference. As prospective home buyers, real estate investors, and stock investors, we need real time data that’s not behind the curve.

As stock investors we need to understand real estate trends because they may lead the market. And as we all know, problems in real estate finance have led to financial crashes, which were largely expressed through falling stock prices.

In my decades in the real estate and mortgage businesses, and in using that data in the 17 years since I left the business, I know that the NAR’s database is the most broad-based, in depth, and timely data of its kind. Yes, it is reported in a biased and self-serving way, but I don’t care about that. I just crunch the numbers.

However, some of the data NAR reports is not current, and that can be misleading. We need to be sure that we are using the most current data.

The NAR has a report that it calls “Existing Home Sales.” But existing Home Sales reports the number of prior sales contracts on existing homes that were formally closed, meaning the date when all the t’s were crossed and i’s dotted.  That normally happens a couple of months after the actual sale took place. By the time it’s reported, it’s a full 3 months or more behind the time of the actual sales, which is when the contracts were signed.

But everybody in the business, including buyers, sellers, and agents, recognize that when a property goes under contract, it is “SOLD!” The few sales that don’t close, go “BOM,” back on the market, and usually sell again quickly, most often at the same or even a higher price.

Meanwhile, the NAR has real time data on sales in its MLS databases. Agents enter those sales in those databases the minute they go under contract. The NAR aggregates that data and reports it about 4 weeks after the end of the month being reported. They call that Pending home sales (PHS).

Use of the word “Pending” makes it somehow seem like it’s not the real thing, when it is. It is  the point at which the  buyer and seller agree on  price and terms. The rest is just a formality that takes time. The market is made when the contract is signed, not when it goes to closing.

The other data report, Existing Home Sales, is a lagging measure that only tells us where the market was 3-4 months ago. If we want to know where the market is now, our focus should always be on what the NAR calls Pending Home Sales.

The ratio of closings (EHS) to the prior 2 months sales contracts is useful data. We’ll get to that later, but first, let’s examine the most recent sales contract (PHS) and price data…

The NAR Gets It Wrong, But At Least the Government Does It Right

The NAR, or its marketing arm Realtor.com, which is an affiliate of NewsCorp subsidiary Dow Jones, could easily give us real time market data. But they don’t. Even the PHS has a 4 week lag.

Surprisingly, the government does it the right way, recognizing sales when the contract is signed, and reporting it each month within a few weeks of the survey date. The weakness in the government data is that it’s a tiny sample survey that often requires significant revision, but the general direction is usually on the button.

Meanwhile the NAR already reported a year to year price gain of 5.2% in June. The NARs price data comes from the MLS June contracts data. So it is good and reasonably current market data.

The NAR reported, and media outlets dutifully regurgitated, that sales contracts (PHS) rose in June, while being down year to year. That report relied on the statistically massaged seasonally adjusted data. The raw, actual data, not seasonally adjusted, showed that the rosy idea that sales were up in June was wrong.

Not only were they down 4% year to year, but they were also down 1.7% from  May. Now, don’t get me wrong, June sales are often weaker than May, but not always. And the 1.7% drop is weaker than usual. Since the housing recovery began in 2011, the average change in June is a gain of 2.1%. So June was weak, any way you slice it. There was no month to month increase in sales.  This continued a pattern of weaker sales that has been going on all year.

Mortgage rates have been rising. That has crimped demand. Real Estate industry shills and media pundits are still blaming a supply shortage for reduced volume.   But sales were actually robust through the period of so called “inventory shortage.”  However, tight inventory has certainly driven house price inflation.

Likewise that inflation and the well-grounded fear of rising mortgage rates drives panicked demand and bidding wars. It’s a vicious cycle that all sounds familiar. It is very similar to what I witnessed in Florida when I sold my house near the peak of the housing bubble in April 2005, and I ended up with 4 buyers aggressively trying to outbid each other to buy my house.

I made a deal and closed in June. Volume peaked in Florida in October of that year.  My timing was fortunate. Sales prices hung around the highs for another year, but volume collapsed. The market had frozen, and it did so very quickly. Very few sellers were able to sell at those peak prices. If you did, it was like winning the lottery.

A financial crisis was brewing in 2006, and was already well under way in 2007 when the drop in home prices began. Meanwhile, policy makers and pundits were either unaware, or ignored it. By 2007, it was too late. The bubble had previously grown to unmanageable proportions, and had begun a disorderly deflation.  The Fed made matters worse when it stopped growing its assets in mid-2007. The Fed froze the size of its balance sheet. Prior to that it had maintained a steady growth rate of around 5%.

Watch Out: The Market Disaster in 2007 Is Replaying Itself Today

Back in 2007, the Fed was anxious to stop a bubble that had already begun to deflate. The first plumes of smoke from the financial crisis fire were already appearing. The Fed exacerbated the crisis when it elected to shrink its bond holdings in 2007 and 2008. It did so to sterilize the alphabet soup programs it had begun to issue in late 2007 to try to bail out the banks, the money market funds, the commercial paper market, and the Primary Dealers.

Back then, the Fed had inadvertently starved the dealers of cash when it stopped buying bonds from them at the same time as the Treasury was issuing hundreds of billions in bonds to fund the TARP. That turned into a catastrophe, which became the Fed’s motivation for QE. It felt that it had no choice but to rescue the Primary Dealers, lest all of those Fed clients lose their yachts. The initiation of QE in turn fueled the financial asset inflation.

Fast forward to today. In September of last year the Fed decided that it would no longer tolerate further expansion of the asset bubble it created. It has created a monster that the Fed thinks it now must, and can, control.

Just as in 2007, the Fed, worried about asset bubbles, is shrinking its balance sheet. But it is too late. The bubbles are out there. The Fed’s QE inflated asset prices. Deflating them again risks a disorderly collapse.

In the current housing market, as house prices rose and incomes failed to keep pace, effective housing demand weakened. The Fed papered that over by driving mortgage rates to artificially low levels. That subsidized buyers and inflated demand. Now the Fed is draining money out of the system. As the Fed shrinks its balance sheet now, mortgage rates are rising. Consequently, home sales volume is weakening.

A year ago I wrote elsewhere that, “As the Fed removes money from the system, that subsidy will shrink and there will be fewer buyers at current prices. Sales volume will begin to shrink faster. Prices will collapse. It will happen once sellers realize that there are no more buyers. The apparent absence of supply that we see today will suddenly become a glut.”

“That’s what happened in 2007. I remember the pundits saying in 2005 and 2006 that the market was healthy because demand was strong and supply was tight. How quickly that reversed, and how devastating the consequences were.”

I believe that we are on the threshold of that today.

One measure that illustrates the process is the ratio of closings to contracts (EHS/PHS). As house prices have surged well beyond the peak of the Great Housing Bubble, the panic to close deals rose to a fever pitch in 2016-17. Lenders, buyers, sellers, and agents ratcheted up the pressure on banks and mortgage lenders to make the deals work. In recent months, 95% of all sales have been closing. That’s the highest rate since 2007.

Lenders are complicit. They ease credit standards, qualifying marginal borrowers who would not have qualified in the past. They pressure appraisers to inflate appraisals. In the end, much of the mortgage credit thereby issued is bad to begin with, supported by weak credit and overvalued collateral.

These are the first loans to go belly up when the price inflation reverses. As those properties are foreclosed, they come back to the market, add to supply, and put downward pressure on prices. Thus the downward spiral begins. As we know, such spirals are not easily reversed. It took years of falling mortgage rates to finally stabilize the housing crash enough for prices to begin to rebound.

While this bubble is not as extreme and widespread as the raging mania of 2005 and 2006, the processes are nevertheless similar. The turn in sales volume is already well under way.

As Time Grows Shorter, This Bubble Is Increasingly Problematic for Investors

Should this matter to stock investors?

Housing demand led the stock market top by a year in 2006-07. Sales volume peaked in 2005. Prices peaked in 2006, a full year before the stock market.

No two market tops are identical, but the beginning of slowdown in the housing market because the Fed is tightening is a warning. It is tightening far more aggressively than it did at the top of the housing bubble. The lead time probably won’t be so generous this time as it was in 2006-07.

As long as the Fed stays tight, the risks of a disorderly unwinding grow.  And the time grows shorter with each passing month.

Unfortunately, history tells us that the Fed is unlikely to reverse course back to easing as long as the broad economic data and measures of consumer inflation remain steady. The Fed is unlikely to react until Janet Yellen’s enunciated criteria of a “material adverse event,” occurs. History also tells us that the markets will continue to plunge well into the loosening cycle.

I have been recommending since last year to reduce our exposure to stocks to as low as possible. I stand by that recommendation. The process of tightening is still in its early stage. The bulk of the pain is yet to come.

Meanwhile, if you need more evidence of the market’s impending decline, check out my special collapse to profit/ collapse to protection report, or check out Keith Fitzgerald’s The Great Reckoning.


Lee Adler

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