Understanding leading and lagging indicators to make informed decisions
For many of us, our house is our biggest investment and asset. Consider these facts:
• According to the National Association of Realtors, the median existing-home price is approximately $280,000. Assuming at least 20% down, that translates into an investment of $56,000.
• According to Fidelity Investments, the average retirement account balance for an investor aged 30 – 39 is $38,400.
We spend a great deal of time trying to better understand the direction of the stock and bond markets, which sectors might outperform relative to others and how the price of oil might impact interest rates and our portfolios. But how much time do you spend understanding the direction of the national housing market?
Understanding the directional changes of various categories within the overall housing market – and why those changes are occurring or occurred – can help investors better understand the general economy and make more informed investment decisions.
It’s a topic people love to discuss – at the local level. Are homes in our neighborhood overpriced? When will “they” stop building new homes? Are we in the middle of another housing bubble? Can you believe how much so-and-so is asking for their house?
Let’s shift the conversation from the local housing market to the national one by examining current national housing data as well as the impact that COVID-19 has caused. But first, some perspective.
The American Dream
According to the U.S. Census Bureau, at the end of 2019, the homeownership rate in the U.S. stood at about 65%. And of the housing units in the U.S.:
• 58% were owner-occupied;
• 31% were renter-occupied;
• 9% were vacant; and
• 2% were for seasonal use.
Housing & The Economy
Do you think that housing generally leads the U.S. out of recessions? Or do you think that housing generally leads the U.S. into recessions? Both are right.
From Macroeconomics 101 we know that economic indicators fall into one of three categories: coincident indicators, lagging indicators and leading indicators, described as follows:
1. Coincident indicators change simultaneously with the condition of the general economy. Examples include real earnings and average weekly hours.
2. Lagging indicators occur after changes to the economy changes. Examples include changes in Gross Domestic Product, unemployment rate, and inflation (measured by the Consumer Price Index).
3. Leading Indicators occur before changes to the economy. Examples include retail sales, the level of new business startups and the most talked about one: the stock market.
Pending Home Sales – Leading Indicator
The Pending Home Sales Index is a leading indicator of housing activity and based on signed real estate contracts for existing single-family homes, condos, and co-ops. Because a home goes under contract 30 – 60 days before it is actually sold, the Pending Home Sales generally leads Existing Home sales by 30 – 60 days.
The National Association of Realtors will issue the next Pending Home Sales Index release on Wednesday, April 29th for March 2020. The results are sure to be followed closely by investors.
Building Permits – Leading Indicator
Building permits must be issued by a government or other regulatory entity before construction of a new or existing building can legally start. The U.S. Census Bureau reports on the number of total monthly building permits every month. Here is what the most recent release captured:
• Building permits for privately-owned housing in March were down 6.8% from the previous month
• Single‐family authorizations in March were down 12.0% from the previous month.
Housing Starts – Leading Indicator
Housing starts are the number of new residential construction projects that begin during any particular month. The U.S. Census Bureau reports on this data every month too and here is what the most recent release captured:
• Privately‐owned housing starts in March were down 22.3% from the previous month
• Single‐family housing starts in March were down 17.5%
Existing Home Sales – Lagging Indicator
The National Association of Realtors publishes monthly data on Existing Home Sales by compiling data of sales and prices of existing single-family homes nationwide, with breakdowns for the Northeast, West, Midwest and South regions.
Also known simply as home resales and including condos and co-ops (but not including new home sales), the Existing Home Sales metric accounts for the larger share of the market, but it is reflective of what happened, not so much of what is about to happen.
The NAR reported that for the month of March, Existing Home Sales dropped 8.5% from February as each of the four regions saw negative numbers, with the West reporting the largest decline. But there was some positive data from the NAR too:
• The median existing-home price for all housing types in March was $280,600, up 8.0% from March 2019 ($259,700)
• March’s national price increase marks 97 straight months of year-over-year gains
• Properties remained on the market for an average of 29 days in March, seasonally down from 36 days in February, and down from 36 days in March 2019
• More than half the homes sold in March (52%) were on the market for less than a month.
Mortgage rates have a very large impact on the overall cost of purchasing a home and therefore can impact home-buying in general. But trying to tether mortgage rates to the housing market is a lot more complicated than you might think, because there are a lot of variables. Consider what happened in the midst of the COVID-19 spread, for example.
• Mortgage rates fell in late February as COVID-19 spread.
• The general consensus – which was logical – was that mortgage rates would continue falling if the spread of COVID-19 intensified, which it did.
• But instead of falling in March, mortgage rates went up dramatically.
Mortgages are Leverage
Again, it is likely that your house is one of your largest assets and investments. And it’s an investment that uses leverage, which can be scary.
In simple terms, the definition of leverage is using borrowed capital to increase the potential return of an investment. Here is an example:
Recall that the median existing-home price is approximately $280,000, which translates into an investment of $56,000, assuming 20% down.
If you sell the house 5 years from now for $342,000 (that’s assuming appreciation of about 4% a year), then your return will be more than 100% on your investment (because your $56,000 down-payment “investment” turned into $118,000).
And while it’s true that leverage works to your advantage when the value of your house rises, it can also lead to big losses if the value of your house falls.
Take the above example. If you sell your house for $252,000 in five years, then you lost 50% on your investment (because your $56,000 down-payment “investment” turned into $28,000).
Thoughts from a Financial Advisor
The easy conclusion to make is that housing has been significantly impacted by COVID-19. Whether housing will bounce back toward the end of 2020 or trend downward through 2021 is anyone’s guess. That is especially true since the realtor’s mantra of “Location, Location, Location” applies as well – it really does depend on where you live.
But if you are considering buying a house – or considering buying a second house – ask yourself the tough questions: what happens if you lose your job? Or get sick? Get transferred to another city? Have a child move back in?
Your financial advisor can help you wade through the data of coincident, leading and lagging indicators so that you can make informed decisions with respect to your personal housing questions. But more importantly, your financial advisor can make sure your financial plan is structured accordingly after you make those decisions.