Today the National Association of Realtors reported that their May Pending Home Sales Index rose 13.4% from May 2010. They said this rise points to “higher housing activity in the second half of the year.” But, how accurately do Pending Home Sales translate into actual home sales? Turns out, not that accurately at all.
What Are Pending Home Sales?
After several years of study and data collection, the NATIONAL ASSOCIATION OF REALTORS® developed the Pending Home Sales Index (PHSI), a new leading indicator of housing market activity.
Based on the data from Multiple Listing Services (MLSs) and large brokers, the index provides advance information on future home-sales activity and offers more solid information on changes in the direction of the market than any of the indicators currently available.
Specifically, Pending Home Sales become Existing-Home Sales one-to-two months later. This means that we can use an index derived from Pending Home Sales to predict actual home sales activity.
- When a seller accepts a sales contract on a property, it is recorded into a Multiple Listing Service (MLS) as a “pending home sale.” The majority of pending home sales become home sale transactions, typically one to two months later.
- Since pending home sales measure actual existing-home sales, the PHSI provides an accurate and reliable indicator of future home sales activity. Our sample shows that over 80% of all pending home sales go to settlement within a 2-month time-period (and a significant share of the rest close in month 3 and month 4).
- Not all pending home sales go to closing. A certain percentage of properties that go under contract are cancelled (or fallout) before ever going to settlement.
- An index of 100 is equal to the average level of contract activity during 2001, the first year to be analyzed. Coincidentally, 2001 was the first of four consecutive record years for existing-home sales. 2001 sales are fairly close to the higher level of home sales expected in the coming decade relative to the norms experienced in the mid-1990s. As such, an index of 100 coincides with a historically high level of home sales activity.
How Accurately Pending Home Sales Predict Existing Home Sales?
So, NAR states that Pending Home Sales do become Existing Home Sales. But their data from the last 13 months tell a different story. The chart below shows seasonally-adjusted data since May of 2010, for the entire United States.
While there probably is some value in the Pending Home Sales Index, it doesn’t appear to be very good at predicting actual closings. At least, not in this current environment. Pending Home Sales rose over 20% from June 2010 to November 2010, which should have translated to a rise in Existing Home Sales from July/August to December/January. But, instead, Existing Home Sales fell 14% during that stretch.
The only variable between Pending and Existing Home Sales is the number of homes that fall out of escrow. If the market environment was consistent – prices, social mood, etc. – then this variable should also be consistent and Pending Home Sales should accurately track Existing Home Sales. Over the last year, this hasn’t happened. Why?
Clearly, more homes are falling out of escrow over the last year. NAR blames tight lending standards for this:
Pending home sales have trended up unevenly since bottoming last June, rising in seven of the past 11 months. “Home sales still could be 15 to 20 percent higher,” Yun said. “If banks would simply return to normal sound underwriting standards and begin lending to more creditworthy borrowers, we’d get a much faster recovery in the housing sector.”
However, this doesn’t pass the sniff test. Most buyers are going to have their financing in order before getting into contract on a house and, because GSEs are the only lenders, lending standards are well-known before-hand. It’s not like 2008 when your lender could go belly up 2 days before funding your loan. Sure, some financing falls apart at the last minute, but I’m seeing less of this now than in previous years.
So, why are more homes falling out of escrow lately? Skittish investors? Is it because short sales can be “pending” for many months, skewing the data?