In this episode of the REconomy Podcast™ from First American, Chief Economist Fleming and Deputy Chief Economist Odeta Kushi discuss which key housing market metrics are leading indicators and share their analysis of what each leading indicator is signaling about the direction of the market.
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Listen to the REconomy Podcast™ Episode 42:
“Overall, the housing market is clearly slowing. But remember that it is slowing by design. The Fed is intent on taming inflation. And one of the biggest components of inflation indices is the shelter components. Slowing housing inflation is one way for the Fed to rein in overall inflation.” – Mark Fleming, chief economist at First American
Odeta Kushi - Hello, and welcome to episode 42 of the REconomy podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark. We're living during very interesting and uncertain times, and in order to better understand what's happening in the housing market, we need timely data, we need leading indicators instead of lagging.
Mark Fleming - Hi Odeta. That's absolutely right, I wo- uld much prefer my information to lead, instead of lag, the market. A leading indicator is a statistic that precedes economic events whereas, obviously, a lagging indicator occurs after the economic event.
Odeta Kushi - Housing market activity, for example, is a leading indicator of GDP. Housing's share of GDP was about 17% in the first quarter of 2022. And housing market activity contributes to GDP in two primary ways -- through residential fixed investment, that's homebuilding and remodeling, and housing services, that's your rent paid by renters and owners imputed rent and utility payments. So, while the official GDP data is a lagging indicator of economic activity -- in other words, we find out about the amount of domestic production after it's happened -- housing activity can be an early indicator of economic activity months in advance. In fact, the housing market has traditionally aided the economy in recovering from a recession, as consumers who are less affected by the downturn are willing to buy and sell, and existing homeowners are able to take advantage of equity in their properties. Homeowners tend to stay put, while things are uncertain and wait to move when they feel more confident, which can help get other parts of the economy moving.
Mark Fleming - That's right. And so, if housing market activity is a leading indicator of GDP, let's dive into some housing market-specific lagging versus leading indicators themselves.
Odeta Kushi - Great idea. And the first is house prices. The commonly reported S&P Case Shiller House Price Index is a lagging indicator. There's a two-month lag in reporting, such that data reported in July will only cover home sales through March. And it is calculated monthly based on changes in home prices over the prior three months. In other words, they're calculated monthly using a three-month moving average. And note that these are sale prices, so the contracts for the sales were set even earlier. So the bidding wars that resulted in a closed contract in January, which became a sale in February of this year, may show up in the June or July house price index. So maybe we turn to median sale prices instead.
Mark Fleming - Maybe, but the truth of the matter is measuring the changes in prices on a heterogeneous good -- meaning all houses are different -- is very, very challenging. But most house price indices capture something that a median sale price will not. A common way of building house price indices is to use the sales-pair method, comparing the price of a house when it was sold in the current month to the price of the same house in prior transactions years and years ago. You pair the sales together. The advantage of this method? Constant quality. What do I mean by that? Sale pair indices are designed to reflect changes in prices, while controlling for the fact that the mix of houses selling, particularly the mix of the prices of houses selling -- small houses, big houses, mansions, bungalows -- that mix of houses selling changes from period to period. Another way to say it is that it measures how much it would take to buy the same unit of house over time. So you get a really clear price signal. Constant quality. Median sale prices of homes, on the other hand, can change due to the underlying mix of sales.
Odeta Kushi - Okay, I see what you're saying. So, if only lower-priced homes sell in DC this month, then that median sale price will fall. But, it's not because prices have declined, but rather that the kind of homes that are selling are valued lower. Sales-pair indices account for this changing mix but, unfortunately, are lagging indicators. So, if the most commonly used house price indices lag the housing market and median prices don't control for the mix of homes selling, then what can we look to?
Mark Fleming - Yes, for this, we have to go all the way back to the beginning. When sellers list their homes for sale -- basically that's the start of the whole home-buying and selling process. This is commonly referred to as listings information. For example, the number of new listings, the number of contracts pending, the amount of properties listed for sale - supply - or the percent of properties with recent price reductions. There's a lot of great leading information that can be gleaned from this listings data about the housing market, in particular, a leading indicator of price trends is the share of homes with price reductions. A rising share means that more sellers are cutting their initial list prices to attract more buyers. Well, the only reason you do that is if there is less demand relative to the supply. That's exactly what's happening in today's market. A rising share of homes with price reductions is an early leading indicator that the supply and demand imbalance that we've talked about many times on this podcast is finally moderating.
Odeta Kushi - Another good leading indicator is the number of immediate sales happening in the market, which means the number of new listings are going into contract essentially immediately. Clearly, the higher the number, the more demand there is relative to supply. That number remains elevated, which is leading proof that supply is still short relative to demand, but is likely to come down as affordability continues to wane. So house price growth is probably moderating, even if the sale-pair price indices don't show it. What about other leading indicators for the housing market? What's the leading indicator of sales?
Mark Fleming - That's right, so we've covered prices. The next thing to look at is the amount of sales activity. We like to look at mortgage applications weekly data from the Mortgage Bankers Association, and the NAR Pending-Home Sales Report. Like sellers listing their homes, mortgage loan applications happen early in the home-buying process, so changes in application activity from week-to-week are a great leading indicator of home buyer demand.
Odeta Kushi - And pending-home sales activity is a leading indicator of housing activity as it measures the amount of housing contracts, signed real estate contracts that typically precede the closing of the sale transaction by about a month or so.
Mark Fleming - Both of these indicators have been trending downwards, which points to fewer sales.
Odeta Kushi - Another indicator of cooling demand. And next I want to talk about homebuilding as a leading indicator of housing activity. And to discuss that we have to talk about a very important monthly report, the new residential construction report. This report includes building permits. Building permits are a leading indicator of future housing starts. Then of course, housing starts, which is groundbreaking on new homes, and housing completions data, all of which are compiled from surveys of homebuilders across the country. Now, this report gives us insight into future housing supply, but it's also a key indicator of broader economic strength.
Mark Fleming - And I'll just add one more to that. And that's the National Association of Homebuilders builders sentiment report.
Odeta Kushi - Right. And these measures, and particularly the permit starts and sentiment report are strong, strong housing market and economic leading indicators. We mentioned earlier that the housing share of GDP is about 17%. Well, homebuilding in the first quarter was about 5% of that. So when we see homebuilding slow, we can expect that to be a drag on overall GDP.
Mark Fleming - And builders will only build if someone is there to buy at the right price. So housing permits and starts will often soften as demand cools, and we're seeing that too.
Odeta Kushi - The unfortunate irony about that statement is that the housing market continues to face a dearth of supply. Builder sentiment and building is declining because, not only have their input costs increased, but affordability for consumers has declined. We know from previous analysis that the new-home market is more rate sensitive than the existing-home market, so it's not surprising that builders are pulling back. So, we've covered leading indicators for prices, sales and new home supply. I think we've got two more -- inventory and affordability. For inventory, we get back to listings data, the number of new listings entering the market, but I think we have to make a little disclaimer about inventory data. Do you know what I'm getting to Mark?
Mark Fleming - Yes, the inventory bathtub, I'll explain. Inventory is most commonly calculated by taking a count of the number of active listings and pending sales on one day, like the last day of the month, and measuring basically an end-of-month stock or the stock at that point in time. Well, when homes are selling very quickly as they've been doing in recent years, many transactions flow in and then out of the stock between those fixed monthly measurement points. Let's say it another way. To give you a visualization of this phenomenon, we use a bathtub as the metaphor. Water flowing into the tub represents new listings, water leaving the drain represents closed sales. And the water level in the tub represents the stock of inventory. At the end of the month, when the water level or the inventory is measured, it may be low, but that doesn't account for the volume of water that flowed through during the month -- home sales that closed.
Odeta Kushi - So I've used this example in the past, but it's worth repeating. Let's say in Washington DC two homes are listed for sale, one on January 2 and the other on February 2. If the homes are on the market for 60 days, the inventory level on February 28 would be two. However, if the homes each sold in 30 days, the inventory count at the end of February. would be one, but the number of home sales would still be two.
Mark Fleming - So beware when you hear the statistics, we may see that the traditionally measured inventory number is increasing. But it may not be from new listings, but rather simply homes sitting longer on the market because of cooling demand. The stock of water in the bathtub gets larger because the flow slows down.
Odeta Kushi - Right. So, a better measure would be the number of new listings entering the market. All right, last, but certainly not least, affordability.
Mark Fleming - This this one is tricky, because housing affordability is a function of three things -- a nominal house price index, income and mortgage rates.
Odeta Kushi - Well, we can get our hands on weekly mortgage rate data from Freddie Mac, or the MBA, and incomes can be estimated from monthly census wage and hours worked data. But that nominal house price index is the tricky part because of the lag in reporting that we were just talking about.
Mark Fleming - That's right. As we've mentioned, the sale-pair base method, while you get the benefit of constant quality, has essentially a two-month lag. We can close that lag a little bit, but not all the way. Otherwise, we have to rely on what the higher frequency listing information is telling us as a leading indicator, or sets of leading indicators, of where that price index might go.
Odeta Kushi - Right. And, as of right now, it looks like prices are still rising on a year-over-year basis, albeit maybe at a slower pace. Incomes are rising as well. But, so are mortgage rates. So it looks like affordability is declining.
Mark Fleming - That's right. Overall, the housing market is clearly slowing. But remember that it is slowing by design. The Fed is intent on taming inflation. And one of the biggest components of inflation indices is the shelter components. Slowing housing inflation is one way for the Fed to rein in overall inflation.
Odeta Kushi - Great point. Thanks, Mark. Well, that brings us to the end of the episode. I hope this episode on leading indicators in the housing market was useful. And, as always, thank you for joining us on this episode of the REconomy podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at firstname.lastname@example.org. We love to hear from our listeners. And, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
This transcript has been edited for clarity.