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Economic Update


Spotlight is on the housing market

May 21, 2014

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Recent soft numbers of home sales and construction and residential investment expenditures prompted Federal Reserve Chair Janet Yellen to note that the performance of the housing sector is disappointing and warrants close watching. The outlook for the housing sector remains positive, but the pace of activity is likely to be moderate compared with prior recoveries.

Sales of existing homes declined in seven of the last eight months ended March, bringing the level to the pace seen in July 2012. Sales of new homes also show a significant sluggish trend. Residential investment expenditures have “flattened out” after advancing consistently for several quarters.

Some of the weakness in the housing sector stems from bad weather in the early part of the year, while higher mortgage rates following previous Fed Chairman Ben Bernanke’s remarks in May 2013 about the Fed’s plans to taper asset purchases also weighed adversely on housing market activity.

A return to normal weather conditions and a partial reversal of mortgage rates should result in a rebound in housing activity. The gain in April housing starts was only partly encouraging, as most of the activity was concentrated in the multi-family sector.

Other headwinds also account for the lack of housing sector momentum. Most importantly, mortgage-underwriting standards are tight, and households with low credit scores face a challenging situation to qualify for home mortgages. The latest Senior Loan Officer Opinion Survey indicates banks tightened mortgage underwriting standards this year in an environment of low mortgage loan defaults and improving employment conditions.

Research of the Federal Reserve Bank of New York concludes that young people with student loans are postponing entry in to the first-time home-buyer market. Student loan defaults have risen from 8.7% in early 2012 to 11% in the first quarter of 2014, which in turn affects credit scores and disqualifies potential first-time homebuyers. It also reduces the ability of existing homeowners to sell and purchase higher-priced homes.

The March Housing Affordability Index at 170.3 is noticeably below the mark (around 200) seen in the period from mid-2011 to mid-2013, when home sales advanced at a healthy clip. Household formation slipped in the first quarter after a lackluster reading during the final three months of 2013, which is yet another reason for the soft trend in home sales.

Investor purchases, often overlooked, are an important source of demand for homes. The National Association of Realtors reports that investors’ share of home purchases declined to 20% in 2013 from 24% a year ago.

Against this backdrop of a soft housing market, the April report for sales of new and existing homes, scheduled for publication later this week, will offer new information about the housing market. Despite the recent gains in employment and projected improvement, the unfavorable mortgage lending environment and other headwinds are likely to moderate the pace of housing market activity in the quarters ahead.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.