by Ethan Roberts | January 4, 2012 11:40 am
Early Wednesday morning, the Mortgage Bankers Association reported that its closely watched mortgage applications index dropped 4.1% in the final week of December 2011, and that purchase applications were down 9.7% from the previously reported period of Dec. 16. It also noted that over 81% of the applications were for refinances, rather than purchases.
But even though this number is closely watched, does it really matter? Will all those mortgage applications actually turn into purchased homes, or will many of them eventually be rejected by today’s tighter lending standards?
Or to put the question another way, given the wide variety and nearly constant flow of reports that cover one aspect or another of the housing and real estate markets, which one(s) matter most?
On any given week, a good deal of real estate data is reported on the financial news wires, yet too often the reports seem to contradict each other — or paint a picture that’s inconsistent at best. For example, many people don’t realize that the MBA’s report includes both new purchase applications and refinances. So when the application numbers rise, it may seem as if a slew of new home purchases are on the horizon. Yet, much of that activity may simply be homeowners refinancing their existing homes.
The result: confused investors who are searching for ways to profit from general trends through real estate-related stocks.
So how do we as investors sort out what’s really going on when closed sales are up, but prices decline, or when pending sales are up, but new building permits or housing starts are down?
Which other reports are the MOST important for us to consider, and which ones mean little? Let’s take a look at the various reports. By scoring each with a grade, say, from A to C, we can identify which ones are the most worthwhile for investors to follow.
Pending Sales (B-): Pending sales represent the number of current contract offers in effect between home buyers and sellers, but which haven’t yet closed.
During the pending period, buyers are going through the financing process, and are having inspections, appraisals and surveys performed to assess the condition, value and parameters of the properties.
Unfortunately, many things can and do go wrong during this process. A lender may find reasons to deny the buyer’s financing. Inspectors may find structural problems in the home that change the buyer’s mind about the purchase. Appraisers may assess the value of the home much lower than the agreed-upon purchase price and the seller may be unwilling or unable to lower their price.
Any of these can be deal-killers. Therefore, using pending sales as a guide to the current or even future strength of the real estate market can often be misleading. In fact, in October 2011, some 33% of pending sales failed to close, a huge increase from the 8% that failed in October, 2010. This increase pinpoints the ongoing problem that tighter lending standards are having on the real estate market’s ability to gain any headwind.
Closed Sales (A-): Closed sales are finalized sales, in which property deeds are transferred from seller to buyer and the seller receives his money. Therefore, closed sales are a far more reliable indicator of the strength or weakness of the real estate market than are pending sales. It’s truly the one report that best represents the strength of the real estate market.
However, the validity of this report was somewhat damaged recently by the National Association of Realtor’s (NAR) admission that it misreported several years of numbers. Hopefully, that situation will be corrected.
Also note that the combination of pending and closed sales reports can confuse Wall Street into acting as if things are improving or declining. For example, we recently had a report of a better-than-expected rise in pending sales, and the Dow climbed 130 points on the news.
That strong pending sales report can prompt the analysts to adjust their numbers to expect a higher closed sales rate in the following month. But if a large percentage of those pending sales fail to close, the market will be disappointed, and analysts will then readjust their earnings expectations (and thus the stock prices) for the real estate-related issues.
Case-Shiller Indices (B+): The S&P/Case-Shiller U.S. National Home Price Index is a quarterly composite of single-family home price indices for the nine U.S. Census divisions, and is the most frequently reported home-price number to the financial markets.
It’s put out by Fiserv, an information management company, and Standard & Poors, which in 2002 jointly purchased Case-Shiller-Weiss, the originators of the indices, which measure repeat sales of the same homes to measure price fluctuations in the real estate market.
The Case-Shiller index is an important number, because it measures prices, and not sales numbers. This is another way to gauge the strength or weakness of real estate markets, because price increases usually precede sales increases, and price declines usually precede a drop in sales.
The reports include a national home price index, a composite index of 20 cities across the country, a 10-city composite index and individual indices for 20 different metropolitan areas.
But because real estate can be strong in some parts of the country, while other areas remain weak, the metro index numbers will sometimes clash with the national numbers, and investors may become confused about the larger picture. So the most accurate report for investors to focus on should be the S&P/Case–Shiller U.S. National Home Price Index.
A better-than-expected Case-Shiller number will frequently push the stock market higher. In addition, options and futures for the Case-Shiller index are traded on the Chicago Mercantile Exchange.
Several different reports shed (or should shed) light on homebuilders, including new permits, new housing starts, closed sales of newly constructed homes and homebuilder confidence levels. Again, these results may sometimes contradict each other, so it’s important to know where each one fits in the larger picture of what matters.
New Permits (B+): New building permits are an excellent gauge of future strength or weakness in the housing market. There’s normally about a six-month gap between a permit being issued and new home construction being initiated. Although not all permits will eventually become new homes, the year-over-year change number is the one that matters in determining the trend of the real estate market.
For example, in September 2011 builders reported that home construction was down nearly 6% from September of the previous year, but permits were up almost 8%. This somewhat confusing report actually showed that although the construction industry hadn’t been building much recently, it was preparing to begin new projects in the months ahead.
For long-term investors this created an opportunity to get in on some homebuilder stocks cheaply before the market showed signs of improvement via closed sales.
Housing Starts (B): Housing Starts are the number of privately owned new housing units on which construction has begun in a given period. The report is divided into single-family, townhomes or small condos, and apartment buildings of five or more units.
What’s confusing is that when construction of apartment buildings is high, it creates a larger-than-usual housing starts number because each apartment unit is counted individually. Therefore, an apartment with 45 units would be counted as 45 starts, rather than one start. This can lead investors to misinterpret the higher count as single-family home starts.
Builder Sentiment (C-): The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) is a monthly survey of builders‘ sentiment about current single-family home sales as well as sales expectations for the next six months. Builders are asked to rate traffic of prospective buyers in terms varying from “very high” to “poor.” Their responses are then scored, with 50 being a “good” number.
Although the accuracy of rating something “good” or “fair” is difficult to assess, the stock market will rally or drop on the HMI survey’s numbers. But because this report is an accounting of subjectivity among builders and tries to quantify narrative responses, its reliability as a market predictor is somewhat limited.
Real estate reports often appear contradictory because each one covers a different aspect of the market and has a different meaning, some reports are more precise than others and there’s often lag times for certain reports that makes it seem as if the real estate market is a giant roller coaster. However, investors should focus on closed sales, the Case-Shiller National Index and building permits as the most accurate indicators of whether real estate-related stocks will do well or not.
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