Home Sales Increase, But Pending Sales Decrease—What Does It Mean for You?

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Seasoned investors understand how real estate statistics vary with … well, the season. But in a year as strange as 2020, it’s hard to know if variances are simply standard seasonal trends or if they represent a larger shift. The pending home sales number for October surprised some people, coming in at a 1.1% decline from September. However, sales were up 20.2% from October of 2019. What does it mean for real estate investors?

Keep in mind that any one data point shouldn’t be weighted too heavily in your decision-making process. This point is even more important in the context of a global pandemic with various segments of the economy shut down. But despite the pandemic, real estate hasn’t suffered much in 2020—in fact, despite predictions to the contrary at the pandemic’s start, it’s continued its multi-year boom.

Let’s look at this year’s numbers and then zoom out a bit for context with these charts from Trading Economics.

Note that the year-over-year (YoY) increases since July have been incredibly strong and driven by a confluence of factors. The rise of remote work, a desire to avoid congested areas due to COVID-19, pent-up demand from the spring season, and incredibly low mortgage rates are all coming together to drive extremely high housing transaction volume. 

Zooming out to a five-year view, we can see that this metric has tended to bounce around in a much smaller range and 20% YoY increases are certainly not the norm. 

While pending sales growth likely won’t proceed at this pace over the coming months, there’s a good chance we will continue to see higher-than-normal volume for several more months. 

There are some serious concerns about the long-term health of the economy, and this may manifest itself in a weaker housing market down the road. But for now, interest rates are low and people are rethinking their living situations like never before. 

Mortgage rates drive the bus

The factors mentioned above have a lot of runway left in them, particularly the low mortgage rates. Home buyers make their decisions based on their expected payments, not the price. With rates this low, and likely to stay low, there will be a steady demand for home purchases. 

Take a look at where mortgage rates were just a couple short years ago compared to now:

Let’s do some back-of-the-napkin math here. 

Median family income for 2019 was $68,703. For simplicity’s sake, we’ll assume no other debts come into play and a family can borrow up to 40% debt-to-income. (This exercise is to demonstrate the power of interest rates, not to mirror real-world data).

With mortgage rates at 5%, this income could support a loan of about $426,000, which implies a home value of $533,000 assuming 80% LTV (rounding for simplicity’s sake). 

If we drop the mortgage rate to 3% and hold everything else constant, that same $68,703 in household income could support a home purchase of $679,000. 

That means that with no fundamental improvement in the economy relating to increases in income, interest rates dropping from 5% to 3% could result in massive price appreciation–27% in the example above. Now in the real world, there are obviously other factors at play. But it is important to understand just how much interest rates are driving the bus. These lower interest rates will also allow existing homeowners to refinance their mortgages and save a ton of money, while businesses can roll over existing debts at a better cost.

We can flip the math around and look at it through income as well. Using the same basic assumptions as above, with interest rates at 5%, a family would require roughly $51,500 of annual income to afford a $400,000 house. At 3%, interest rates would allow families with incomes of $40,500 to qualify for a loan to purchase the same $400,000 house. Lower interest rates open up the housing market to far more participants who had previously been priced out of the market, as a 20% reduction in income could still support the same house payment. 

To be clear, it’s vitally important that the overall property payment, including insurance and taxes, is carefully considered alongside one’s household or investment budget. But assuming the overall payment remains within budget, the same house payment, dollar-for-dollar, will buy more house when interest rates are lower.

This interest-rate-led demand, together with a consistently short supply of inventory, has been driving home prices higher, and this trend may well continue through the spring buying season. 

We can see this in the sharp uptick in the Case-Shiller U.S. National Home Price Index. 

Over the short term, these factors could continue to drive sales volume and pricing increases. The question then becomes when (if ever) does the music stop?

Issues to watch

Over the longer term, there are debt and demographic issues facing the country that will likely lead to sluggish economic growth and income growth, with continued low interest rate policy coming out of the Federal Reserve. Inflation is something to watch for down the road but is less of an immediate concern. 

Given that stance, it does seem the housing bull market is somewhat artificially driven, in the sense that the market is influenced greatly by interest rates and a lack of supply in an affordable price range, and not necessarily driven by growing high-quality employment, improving wages, or general economic strength. That indicates that these increases are despite the pandemic, not because of the pandemic. While many buyers have been fueled by the drive for more space, the interest rates and lack of supply are primarily what has driven this quite dramatic increase.

The key to the residential market will be understanding if and when interest rates level off or rise, and whether or not we’ll see a renewed wave of economic difficulty as government benefits expire and people and businesses struggle to catch up on mortgage and rent payments. This could lead to another round of layoffs and a reversal in the demand for housing. 

In the meantime, a likely shift in the next few years is homebuilders readjusting their focus to suburban subdivisions to meet the changing demand of home buyers. The construction of single-family homes never really recovered to the same extent as rental units after the 2008 crash. We may see this segment retake the spotlight soon. 

A bifurcated market  

We can often lose some nuance when we’re talking about broad market trends. In this case, it’s important to note that while we’ve seen severe spikes in unemployment, the economic impacts of the recession have been disproportionately felt by workers in the service industry–restaurants, hotels, and travel. White-collar jobs have been far less affected up to this point. 

This market dynamic should be closely monitored. If the economy remains sluggish and the income and employment prospects of the middle to upper class begin to shift, the tailwinds of ever-lower mortgage rates may at some point be outweighed by increasing economic impacts on potential home buyers. 

Over the short-term, however, expect to see strong demand for housing continue as low mortgage rates and optimism about a recovery and COVID-19 vaccines give buyers the confidence to go out and buy. 

What’s your take on the most recent home sales and pending home sales numbers?

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.