February 4, 2009 (Housing Market Monitor)

Jumps in South and Midwest Boost Pending Home Sales Index in December

By Dean Baker

February 4, 2009

Oversupply may cause prices in the Northeast to plummet this spring.

The National Association of Realtors’ Pending Home Sales Index jumped 6.1 percent in December, driven by a 13.0 percent increase in pending sales in the South and a 12.8 percent increase in the Midwest. Pending sales fell by 3.7 percent and 1.7 percent in the West and Northeast, respectively.

Because of the high share of foreclosed properties among sales, it is not necessarily clear what is indicated by an uptick in this index. A large number of bank auctions of foreclosed properties is as likely to be the factor driving up sales as any genuine increase in demand. Sales of foreclosed properties have become especially important in California, where nearly 1 percent of homes received a foreclosure notice in December.

The drop in pending sales in the West was most likely due to the timing of foreclosures. A new law requiring that lenders make an effort to contact homeowners before foreclosure reduced the number of filings in the fall months. However, there was a big jump in December, which could indicate that the number of foreclosed properties on the market will increase again.

The drop in pending sales in the Northeast could indicate that the bubbles in cities like New York and Boston will soon be deflating more rapidly. The price declines in these cities had been relatively mild thus far, even though the price-to-rent ratios in these metropolitan areas indicated that house prices in these markets were substantially overvalued.

Pending sales in the Northeast are down 14.5 percent from their year ago level and 37 percent from their year-round average in 2006. This is by far the sharpest decline in the four regions. With more homes being placed on the market as spring comes, this could presage a much sharper rate of price decline in the region.

The Case-Shiller tiered indexes show that houses priced in the lowest tier continue to see the most rapid rate of price decline in most cities. In Washington D.C., the average price in the bottom tier fell by 4.5 percent in November. In Miami, prices in the bottom tier fell by 3.0 percent and in San Diego, by 3.6 percent. In Phoenix, prices in the bottom tier fell by 6.0 percent in November.

This rate of price decline indicates the enormous benefit that potential homebuyers would have experienced by waiting to buy a home over the last year. In the case of Washington, D.C., the average price of a home in the bottom tier fell by 33.4 percent over the last year. For a home at the current $293,700 cutoff for the bottom tier, this would imply a gain of $147,100 compared to buying in November of 2007.

In Phoenix, home prices in the bottom tier have fallen by 43.5 percent over the last year. For a home priced at the cutoff level for the bottom tier, currently $145,100, this implies a gain of $111,700 from deferring a purchase from November of 2007 to November of 2008.

The flip side of this story is that loans issued on homes in these markets are likely to be far underwater. This is likely to be true even of loans issued in recent months. For example, prices for homes in the bottom tier in Washington fell by 19.5 percent from May to November. This means that a loan issued with a 20 percent down payment in May is likely to already be underwater, after factoring in selling costs.

As a result, lenders in the bubble markets are likely to be seeing substantial losses even on loans issued in 2008. These losses could have been easily avoided if lenders set appraisal prices based on appraised rents (e.g. 15 times annual rent). In the case of Fannie Mae and Freddie Mac, this may end up being a hot political issue in the near future if they need more money to cover their losses. It would be difficult to justify their refusal to change their lending policies even after the bubble had become painfully apparent to the whole country.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.