In each Economic Update, the Research staff analyzes recently released economic indicators and addresses what these indicators mean for REALTORS® and their clients. Today’s update discusses mortgage applications and worker productivity.

• Mortgage applications to buy a home fell slightly in the past week. Though there is natural volatility in this data from week-to-week, the broad trend has shown no meaningful increase. This is surprising in that both new and existing home sales have been rising in the past 12 months.
• The rise in all-cash transactions over the past few years partly explains the rise in home sales but no commensurate rise in mortgage activity. Also, the data measures only mortgage applications and has no information about approval rates.
• Mortgages for refinances, however, have been rising as mortgage rates touched a new bottom from the euro-zone debt crisis. Refinances will help the broader economy as more homeowners will have extra leftover money to pump into the economy. However, in the short term mortgage lenders will direct staffing to grind out refinances and will therefore be in less of a hurry to process mortgage applications for home purchases. Though counterintuitive, a slight rise in mortgage rates is expected to help home sales.
• In separate economic news, worker productivity slid in the first quarter. The hiring of additional workers did not lead to a commensurate rise in overall production. Though a disappointing quarter, worker productivity did still squeeze out a slight gain of 0.4% from one year ago. On average, each U.S. worker is able to produce about 2% more every year from the same labor hours due to improved technology and better business practices.
• Though less talked about compared to other economic data, the rise in productivity will be the main source of rising worker salaries over the long-haul. Once U.S. productivity started to outpace Britain’s about a century ago, the U.S. economy easily surpassed that of the once mighty British Empire. Back in the 1980s, there was talk of Japan overtaking the U.S. but that never happened because U.S. productivity outpaced that of Japan. Today, however, worker productivity in China is rising notably faster than that in the U.S., such that an average worker salary in China could double to about $12,000 in 10 years. If that happens, and given China being four times more populous than the U.S., the Chinese economy would have overtaken the U.S. at least in terms of the size of the total economic pie.

Already home prices are turning up.  Though many economists have been calling for no price gains or only very minimal gains over the next several years, a surprise upside looks to be quickly developing.

First, let’s review the data.  NAR’s median price of all homes transacted in April showed a monthly gain of 7.6 percent.  However, the median price is not a good reflection of genuine price appreciation of a person’s home because it is influenced by which types of homes are getting sold during that period.  If only the upper-end is moving, then the median price will be high.  If only the lower-end, then the median price will be low.  Also, April is the time when families with children start to buy and they typically purchase a larger-sized home that tends toward the higher price points.  The median price, though it may not genuinely reflect an appreciation of a person’s home, is nonetheless vital information for computing GDP contribution from home sales.

There are many price indices that try to measure the price appreciation of a typical person’s home.  All have slightly different computation methods.  But all are beginning to say the same story: that the worst is over and the prices are stabilizing or rising.  The following table shows home price changes in the latest available month and what it would be if the monthly gains can be sustained over the next 12 months.

REALTORs® well understand that all real estate is local.  Unlike commodities that can be easily shipped to any place, one cannot simply lift a home in Detroit and fly it over to San Francisco to exploit a price arbitrage.  Local market variations therefore clearly exist, which REALTORS® need to explain to their clients.

Note that the latest available data is not June, the current month, because of the lag time in data collection process.  It is worth noting that home price has an additional special lag that arises from the nature of the home buying process.  The March data, for example, was the price negotiated and agreed to in November or December, if not earlier.  So the most current house price information that is being flashed across newspapers and TV screens actually reflects what happened six or more months ago, when inventory conditions could have been measurably different than conditions now.

What is occurring now is that inventory shortages are developing in increasingly more markets.  The total number of homes with a ‘for sale’ sign in April was 2.54 million.  This figure is the lowest April tally since 2005.  Recall that the housing market was booming and bubbling in 2005.  We are not in a boom because one important difference between now and then is that housing demand is about one-third lower.  Nonetheless, the current supply and demand dynamics is such that we are essentially back to normal.  Historically 6-months supply of inventory is the norm and that is what we have been consistently experiencing for several months. Because the total inventory count do not measurably rise from April levels as we proceed through the rest of the year, the 6-months supply will stick and a 5-months supply is not out of the question.  Such conditions imply home prices will be rising 3 to 5 percent annually.

In addition to the falling inventory of existing homes, there is a dearth of newly constructed home inventory.  The latest is only at 146,000 new homes for sale, it is at the lowest since the data was collected 50 years ago.  The difficulties in obtaining construction loans by small-sized homebuilders are restraining growth in the industry despite the falling inventory conditions.  The big builders like Lennar and Toll Brothers can issue bonds and tap Wall Street capital, but not the small homebuilders.  The current rate of housing starts is less than half of historical annual average, and this low construction activity has been persistent from late 2008.  Therefore, the pipeline of new home inventory is already very thin and is not filling in any notable way.  This lack of new home construction will also play a bigger role in lifting home prices faster for at least the next 2 years than most analysts expect.

Finally, what about the shadow inventory – those homes not yet on the market but that will surely land there given the large number of delinquent mortgages.  There is clearly a shadow, but the current number of seriously delinquent mortgages (at least 3 months late or in foreclosure process) is smaller than what it was one year ago.  One year ago, the shadow was smaller than two years ago.  In other words, even the shadows are no longer a threat to home price growth.  Based on steadily thinning out delinquent mortgages, the number of distressed property sales will fall to about one-quarter of all transactions by the year end from the current one-third.  This time next year, distressed sales could comprise maybe only 15 percent.  Therefore, the falling share of distressed sales over time will be another factor that lifts home prices.  There is no reason to shop for a shadow inventory costume for next Halloween because it is no longer scary.

In my view, the absolute low point in home prices has already passed in many markets.  Home price measurements, due to lag time, will confirm that in the upcoming months.  But given the rock bottom low mortgage rates and continuing low home prices, it is still a dandy time to be a homebuyer.