Overview: Housing activity was mixed in October -- with a surprise increase in existing home sales -- the first one in eight months. New home sales decreased in October, following increases in the previous two months. New home sales were also revised lower from July through September, continuing a pattern of downward revisions to the initially reported data of the past several months.
Year-to-date total home sales (new plus existing) through September were 9.5 percent below those in the first ten months of 2005. The decline in the new home market has been more pronounced than that for the existing home market, with year-to-date sales down by 17.7 percent, compared with an 8.0 percent decline for existing home sales. Inventories for all types of homes increased for the month. The months' supply for existing homes was 7.2 months in October compared with 4.8 months last October. Condo months' supply rose sharply to 9.1 months from 5.4 months from a year ago. Reversing two consecutive monthly declines, the months' supply for new homes increased to 7.0 months in October from 6.7 months a year ago.
Builders sharply cut back on new construction in October in response to large buildups of inventories. Year-to-date total housing starts have been 11.1 percent lower than those in 2005. The decline over the past year has been more pronounced in single-family starts, with year-to date starts 12.5 percent lower than those last year. Year-to-date multifamily starts were 4.0 percent below last year's.
Permits declined 5.2 percent in October to the lowest level in nearly 6 years. This was the ninth consecutive monthly decline. Because of a long lag between permits and new home completions, the decline in permits over the past 9 months has not yet lowered supplies of new homes on the market.
Sharply rising unsold home inventories are increasingly hurting sellers' pricing power. The median price for single-family homes declined 3.5 percent in October -- the largest year-over-year decline on record. This is also the third consecutive decline -- the first time that occurred in the series dating back to 1967. The median price for condos declined 5.3 percent from a year ago -- the fifth consecutive monthly decline. New home price appreciation has been volatile over the past several months. The median price for new homes increased 1.9 percent in October from a year ago, following a 9.2 percent decline in September.
It is important to note that median price measures can be distorted significantly by changes in the mix of sales activity. For example, a shift in the mix of sales from higher-priced to lower-priced areas could artificially depress the change in the median existing home price for the nation. A more informative measure of home price performance is the Home Price Index (HPI) from The Office of Federal Housing Enterprise Oversight (OFHEO). The HPI is a superior measure because it is derived from repeat sales transactions, where changes in the values of the same houses are measured over time. Thus, unlike median price measure, home price changes calculated from the HPI are not distorted by changes in the mix of sales activity.
The HPI painted a different picture of the housing market, one of a continuing deceleration in the market as opposed to a drop in the level of price. According to the OFHEO HPI, prices increased in the third quarter at a 3.5 percent annualized rate -- the slowest pace since the second quarter of 1998. On a year-over-year basis, home prices still showed healthy gains at the national level -- increasing 7.7 percent in the third quarter, decelerating from 10.3 percent in the second quarter. One limitation of the HPI is that the data come from Fannie Mae and Freddie Mac and thus they do not cover the entire market but are based on the value of homes financed with conventional conforming mortgages.
Housing Market Projection
Leading indicators suggest that housing activity will moderate further in the coming months but the decline should be less significant. Some encouraging signs have already begun to emerge in the housing picture. The National Association of Home Builders/Wells Fargo Housing Market Index appears to have reached a trough. While the index remained at multi-year lows in November, it has increased four points since September. The Mortgage Bankers Association purchase application index -- a reliable leading indicator of home sales -- increased by 6.4 percent in November -- and continued to pick up in December. The four-week moving average of the index, which removes week-to-week volatility, has trended up since reaching its recent lows in mid-November. However, the index has remained significantly lower than least year's levels.
Long-term interest rates have remained well below recent peak levels as a result of the market's expectation of Fed easing. The yield on the 10-year Treasury fell to 10-month lows in early December, bringing down the interest rate on 30-year fixed rate mortgages to below 6 percent. Given our views of Fed policy, we expect long-term rates to trend up again as stronger economic activity resumes this spring. The increase will be modest, however, as economic growth should be below average through next year. We expect that fixed-rate mortgage rates will remain low, averaging about 6.2 percent by the end of 2006, and are projected to rise to about 6.5 percent by the second half of 2007.
For all of 2006, new home sales are projected to decline about 18 percent relative to 2005 levels, compared with about 9 percent for existing home sales. Sales are expected to decline through the middle of 2007 before picking up slightly in the second of the year. For all of 2007, new and existing home sales should pull back another 10 percent and 8 percent, respectively, relative to 2006.
We expect total housing starts to decline by about 13 percent in 2006 relative to 2005. The decline will be more pronounced in single-family starts, which are projected to decline by 14 percent, compared with about 5 percent for multifamily. Homebuilding activity is expected to hit bottom in the second quarter of 2007. For all of 2007, housing starts should decline further by about 14 percent relative to 2006.
Rising inventories of unsold homes should cause home price gains in 2006 to moderate significantly from the strong pace of 2005. We expect the gain in the median home price for existing homes to slow significantly to about 1 to 2 percent in 2006 and to remain flat in 2007. New home prices should be flat in 2006 and 2007.
Mortgage Market Projection
For all of 2006, we project that purchase originations will decline by about 8 percent from last year's record level to $1.39 trillion. Even with recent declines in mortgage rates and projected low mortgage rates through the rest of the year, refi originations should drop off significantly from last year. However, as a significant share of loans with adjustable rates will face their first reset next year, we expect that a portion of these loans will be refinanced into either fixed-rate mortgages or into other adjustable-rate mortgages with an initially lower rate, providing some support for refi activity. We expect refi originations in 2006 to decline by about 28 percent relative to 2005 to $1.09 trillion.
Total originations in 2006 are projected to decline by about 18 percent to $2.48 trillion (the fifth-highest level ever) from an estimated $3.03 trillion in 2005 (the second-highest level ever). They should decline by an additional 11 percent to $2.21 trillion in 2007 due to further declines in both purchase (7 percent) and refi originations (16 percent).
Despite the narrow spread between fixed-rate mortgage and adjustable-rate mortgage yields, the share of loans with adjustable mortgage rates (both purchase and refi) has remained elevated at about 25 percent of the number of loans by the end of November, according to the Mortgage Bankers Association weekly survey of mortgage applications. The share of loans with adjustable mortgage rates from the Federal Housing Finance Board (FHFB)'s Mortgage Interest Rate Survey (which only includes conventional loans for home purchase) showed a more pronounced decline in the usage of adjustable rate mortgages from 31 percent at the beginning of the year to 15 percent in October. We believe that this measure of the ARM share will remain at about 14-15 percent through the end of 2007.