The Guest Blog

Farr: The Ugly State of Housing


Traders appeared to cheer the news Thursday that existing home sales rose slightly in Augustfrom the lowest reading on record in July (survey began in 1999). Following the release of the data, stocks recovered most of their early losses. Existing home sales were up 7.6% in August (compared to July) to an annualized rate of 4.13 million units - slightly ahead of the consensus estimate of 4.10 million units. On a year-over-year basis, however, existing home sales fell 19% compared with August, 2009. While a portion of the YOY drop can be attributed to the anticipated expiration of the $8,000 tax credits late last year, it should also be noted that mortgage rates are now materially lower than they were last year.

It was the government's hope that ultra-low mortgage rates, spurned by the Fed's purchase of a trillion dollars in mortgage-backed securities, would ignite more demand for houses. The waiting continues.

Combining the new data with the other housing data we received earlier in the week, the picture is not very pretty.

On Monday, we got theNational Association of Homebuilders index. This index is comprised of a three-question survey of homebuilders, and it seeks to uncover sales and traffic trends. The survey came in below expectations at 13 (consensus estimate was 14) - in line with last month's reading and the lowest level since March 2009. It does not appear as though builders are very confident about their current or future sales. But hold on...

On Tuesday, we received Housing Starts and Building Permits. Both figures came in better than expectations. Housing Starts rose 10.5% sequentially to 598,000 (consensus was 550,000), and Building Permits rose 1.8% sequentially to 569,000 (consensus was 560,000). However, the Housing Starts gains were driven by a 32.2% increase in multi-family units, which tend to be highly volatile from month to month. Starts of single-family houses, which represented 73% of the total starts, rose a much more modest 4.3%. The same was true for Building Permits, which, absent the growth in multi-family permits, fell to the lowest level since April 2009.

Foreclosed California home

But let's forget about the breakdown in the Housing Starts and Building Permits figures for a moment.

Let's ask a more fundamental question: Should we be rooting for growth in these key housing indicators right now?

Is it wise to be adding inventory at a time when there are massive backlogs of inventories sitting on bank balance sheets just waiting for a chance to hit the markets?

We would probably argue that it is not wise. As everyone knows, if you increase the supply and demand does not improve, prices fall. It seems we should be rooting for builders to keep production at very low levels for the time being.

And finally, on Wednesday, we received the Federal Housing Finance Agency's Home Price Index.This index measures prices for repeat transactions (identical houses) using data from Freddie Mac and Fannie Mae (huge database). The index posted a 0.5% decline in July - the second consecutive drop following three months of positive growth. The drop was also greater than the consensus estimate for a 0.2% drop. We believe this is a valuable indicator of home prices because it measures repeat transactions, and therefore is not affected by any change in the mix of sales (ie, if more expensive homes were sold this month compared to last month). That said, the return to negative growth over the past two months is not a good sign.

Housing is no doubt inextricably linked to employment. However, we have argued (and continue to argue) that the housing market is not being allowed to clear. The fact that so much supply continues to exist even in an environment of 4.5% mortgage rates is an extremely concerning issue. If sellers can't sell without dropping prices now, what will happen to prices if mortgage rates rise? But ah, we know the government won't let that happen. We firmly believe that Bernanke and friends will be back in the market buying bonds just as soon as the housing situation becomes more clear.

And that may not be very far in the future.

Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C.  Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.