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Why pending home sales ticked up, driven by move-up buyers

Brent Nyitray, CFA, MBA

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 (the NAR). It 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 real estate market’s health. 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.

Highlights from the report

The Pending Home Sales Index (the PHSI), a proprietary index from the National Association of Realtors based on contract signings, rose 0.1%, to 95 in January from 94.9 in December. The index was 9% lower than January 2013. Poor weather and decreasing affordability has been pushing sales lower.

The PHSI rose 2.3% in the Northeast, but it’s 5.3% above a year ago. In the Midwest, the index decreased 2.5% and is 9.3% below a year ago. The South rose 3.5%, while the West Coast dropped 4.8% and is down almost 18% from a year ago. It appears things are starting to pick up in the previously sluggish Midwest. NAR is forecasting existing home sales of 5 million in 2014 with price increases of 5% to 6%.

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 focusing 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. The company believes this lull is temporary, and that the secular (long-term) story for 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), and Toll Brothers (TOL) for years to come. An alternate way for investors to bet on housing would be through the S&P SPDR Homebuilder ETF (XHB).

To learn more about investing in homebuilders, see the Market Realist series Toll Brothers 1Q14 earnings report: Margins keep expanding.

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