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Pending home sales fall as rate increase begins to bite

Brent Nyitray, Sr Real Estate Analyst

Pending home sales are a forward indicator of residential real estate sales

The Pending Home Sales index is put out by the National Association of Realtors (NAR) and tracks the number of home sales under contract. This tends to lead the actual home sales data by a few months. Home sales data is an indicator of the health of the real estate market. Recently, the market has been characterized by limited supply, as homeowners who aren’t desperate to sell have removed their properties in hopes of getting a better price. While the headline real estate appreciation numbers have been large, they’ve been concentrated primarily in the major West Coast markets, especially the markets hit the hardest in the downturn. The rest of the country has been experiencing low single-digit appreciation.

(Read more: Bernanke’s comments send mortgage rates screaming higher)

Highlights from the report

The Pending Home Sales Index (PHSI), a proprietary index from the National Association of Realtors based on contract signings, rose 0.4%, to 110.9 in June from 111.3 in May. The index was 10.9% higher than June of 2012 and marks the 26th consecutive month of year-over-year increases. Last month was the highest since December 2006.

The PHSI was flat in the Northeast, but it’s 12.2% higher than a year ago. In the Midwest, the index fell 1% but is still almost 20% above a year ago. The South fell 2.1%, while the West Coast increased 3.3% and is up 4.4% year over year. It appears things are starting to pick up in the previously sluggish Midwest. Total existing home sales are projected to increase 8% to 5.07 million homes. The median existing home price is forecast to increase 11% to nearly $195,000.

(Read more: Mortgage rates fall slightly)

Implications for homebuilders

Given that the first-time homebuyer is still in a difficult financial situation with a weak job market and high student loan debt, homebuilders are focused more on the move-up buyer. Until recently, the move-up buyer was more or less stuck because of negative equity, or a complete lack of entry-level homebuyers. With professional investors bidding up property, move-up buyers finally have an outlet for their current home. That said, the theme of the real estate market is still restricted supply. A lot of capital has been raised for rental properties, and sellers are noticing that prices are increasing again. The lack of existing homes for sale has helped create demand for new homes.

A combination of higher borrowing rates and limited supply has made the first-time homebuyer pull back from the market. PulteGroup (PHM) noted a decline in orders, driven by increasing rates. The luxury end of the market seems to be doing okay, the slowdown is at the lower price points. They believe this lull is temporary, and that the secular (long-term) story for the builders remains strong.

The return of the first-time homebuyer is the missing link to a more normal housing market. Household formation numbers have been depressed since the Great Recession began, as college graduates found it difficult to find jobs and moved back home. As the job market improves, the household formation numbers are increasing once again. Most of these people will be renters, at least to start. However, the rent-versus-buy difference is as skewed as it’s ever been in favor of buying. This pent-up demand will drive homebuilders, like Lennar (LEN), KB Homes (KBH), PulteGroup (PHM), Meritage (MTH), and Ryland (RYL), for years to come.

(Read more: What to watch for in real estate next week)

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