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Get Four
|  | NOVEMBER 9, 2005
By Michael Englund Don't Let Housing's Seasons Scare YouIs the sky truly falling on the U.S. real estate market? The historical record is loaded with up-and-down cycles tied to the time of yearShould participants in the U.S. housing market take a cue from the title character of the latest Disney (DIS ) film, and wonder if the sky is falling? Industry reports of moderating prices -- and a profit warning from major builder Toll Brothers (TOL ) on Nov. 8 -- have raised worries about a significant downtrend in home prices (see BW Online, 11/9/05, "Housing: Red Alert, or a Wake-Up Call?"). But is there cause for alarm? Not really. The answer lies in one key word: seasonality. Indeed, the recently released monthly data imply little about annual trends. Prices decline sharply in nearly every fourth quarter in this highly seasonal industry. Declines are particularly big in years that have seen large gains in the second and third quarters -- like 2005. CHARTING PRICE TRENDS. With that in mind, we at Action Economics decided to take a closer look at this seasonal pattern in existing-home sales prices and show why there's little hard evidence of moderation beyond the seasonal drop -- a pattern that's more potent than many analysts realize. The table below shows quarterly annualized growth in median existing-home sales prices this year vs. the average of the last 10 years, 20 years, 30 years, and since the start of our data set in 1968.  To gauge price trends, the market follows these "not seasonally adjusted" data, as well as anecdotal reports from industry participants about listing prices, offers above list, the volume of multiple offers, and the time on the market for each existing home. LAGGING BEHIND. These anecdotal reports, which reflect the opinions of individual real estate agents and housing-industry executives, are subject to the same seasonal swings as median prices overall. Hence, reports of moderation late each year, and early in the following year, are always suspect. This problem is aggravated by the fact that the seasonal declines in the fourth quarter are particularly large in years when the seasonal surge in the second and third quarters is large as well, thus turning normal seasonal gyrations into market-moving headlines. Better price data can be found in the quarterly average price figures for "repeat sales" from the Office of Federal Housing Enterprise Oversight, but with painfully long lags: The last available report is for the second quarter of 2005. Because of the delay in release times -- third-quarter data aren't be reported until Dec. 1 -- the figures can't provide clues on more recent price trends. But the chart is still instructive: The big price overshoot in the first and second quarters suggests that a significant moderation could eventually be reported for the third and fourth quarters, without having any meaningful negative ramifications for price trends as we enter 2006. Why? First-half overshoots are often followed by second-half undershoots from the annual growth trend.  GEOGRAPHICAL LINES. This exacerbation of seasonal patterns in existing-home prices is probably due to the big shift in the composition of the housing stock toward the South and away from the Northeast. The order of strength in this seasonal pattern places the South first in line, followed by the Midwest, the Northeast, and the West. The average second-quarter price growth rate in the South has reached 22% over the last 10 years, from a still-impressive 17% rate over the last 36 years. But narrow the focus to the final quarter of the year, and seasonality rears its head yet again: The region's prices on average have declined by a hefty 6% for that period over the last 10 years. In the Midwest, we see slightly less powerful second-quarter price growth rates of 18% over the last 10 years, and 14% over the last 36 years. The fourth-quarter price declines in this region are relatively big, however, with an average 10% drop over the last 10 years, and a 7% rate of decline for the 36 years. This year, the price surge in the second and third quarters was particularly severe, with quarterly growth rates of 62% and 16%, respectively. SPRING BREAK. The Northeast seasonal swings are more subdued by comparison, though still significant. We see average price growth of 8% in the second quarter over the past 10 years, with an even-bigger 10% growth rate in the third quarter. This year, Northeast prices actually fell at a 5% rate in the second quarter, but only because of the atypical forward lurch of 50% in first-quarter prices. Seasonal swings are arguably the smallest in the West, though it saw a particularly large second-quarter surge this year, with growth of 47%. This has been followed by a more concentrated contraction as we enter the fourth quarter, with a projected 20% pace of decline. Though the fourth-quarter drop seems impressive, it just reverses part of the early surge, leaving a full-year price gain of 12%. In general, these powerful seasonal patterns reflect known real estate trends. The spring tends to be a sellers' market -- with a supply-demand imbalance that's particularly large in boom years -- and the quarter in which most transaction volume is initiated. The bigger the boom, the bigger the correction. It will be especially hard to read anything into fourth-quarter price data, and into similarly "unadjusted" anecdotal evidence from industry experts, until we enter the next high-volume period in the coming spring. WAIT AND SEE. Financial markets have generally viewed anecdotal comments that transaction volume and price measures are now cooling as signs of trouble for the housing market. But like the fictional fowl struck by the acorn, they appear to be jumping to a premature conclusion. The declines thus far in reported median prices for existing-home sales are small compared to the outsize advances in the first three quarters of the year. Furthermore, the cycle seems to mirror the powerful and widening seasonal swings that are typical for the industry. The bottom line: It's hardly clear that recent reported price drops are significant in the context of seasonal patterns. The jury will remain out for this sector until we enter the next typical period of price strength for home sales -- the second quarter of 2006. Until then, for the housing market, a wait-and-see approach is advised.  Englund is chief economist for Action Economics
BW MALL
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