Real estate is usually the largest single asset that most people will purchase during their lifetimes.
It’s also a huge asset class. In the US alone, residential real estate is nearly a $40 trillion asset class (about $120,000 per person).
So there’s a lot of interest in being able to develop a view of how to predict the housing market.
Over the long-run, residential housing approximates the rate of inflation. But because of the leverage in the sector, there are swings around it. Sometimes the rate of return can be much better and sometimes much worse.
Inflation (red) vs. Case-Shiller US National Home Price Index (blue)
(Sources: S&P Dow Jones Indices LLC; US Bureau of Labor Statistics)
In all markets, there are lagging indicators and leading indicators.
Lagging indicators include:
- Employment / Unemployment Rate
- Home Prices Index
- Corporate Profits and
- Labor Cost per Unit of Output
- New Home Sales
- Existing Home Sales
Leading indicators includes:
- Mortgage Rates
- Building Permits
- Housing Starts
- Stock Indices (e.g., XHB homebuilders ETF)
- Lot Sales
- Builders’ Confidence
- National Association of Home Builders – Prospective Buyer Traffic
Let’s look at them one by one.
The unemployment rate is a lagging indicator that is closely watched by analysts. A low unemployment rate indicates that there are more people with money to spend, which in turn boosts demand for housing.
However, in a normal recession, its credit that falls first, followed by a cutback in the labor supply.
Home prices index
Home prices index (HPI) measures changes in home prices across a geographical region or market.
HPI, however, reflects what has already happened in the past.
Corporate profits are a broad measure of the profitability of businesses in an economy.
It is closely watched by real estate analysts as it is an indicator of business activity and demand for office and commercial space.
A decline in corporate profits usually leads to a decrease in demand for office and commercial space, which then affects the prices of these properties.
However, corporate profits are released with a lag.
For example, if a company is reporting earnings in late April, it was for the January to March period.
Labor cost per unit of output
Labor cost per unit of output is a measure of how much businesses are spending on labor relative to the output they produce.
Analysts look at it to indicate how much businesses are willing to expand their operations.
If labor costs are rising faster than output, it can signal that businesses are cutting back on expansion plans, which can lead to a decrease in demand for commercial and office space.
But labor, as mentioned, is commonly a lagging indicator. It is one of the last things to go. Labor markets are typically quite tight at the onset of recessions.
New home sales
New home sales is the number of newly constructed homes sold and closed during a given period.
This is one of the most closely watched real estate indicators because it is an indicator of demand for housing (and consequently prices).
Some would argue that new home sales is more of a leading indicator.
They might say it reflects future demand for housing and can signal how strong the market will be in the months ahead.
However, new home sales reflects sales that have already been completed. It does not predict future sales as well as true leading indicators.
Existing home sales
Existing home sales reflect closings, with contracts typically signed a month or two earlier.
So, for example, May existing home sales figures reflect deals signed in April or March.
Mortgage rates are one of the most important leading indicators in real estate. Because houses are so expensive – usually several multiples of one’s annual income – the majority of a house is usually bought on credit.
Mortgage rates in the US are heavily determined by the yield on US Treasury bonds. The 10-year in one of the most well-tracked rate benchmarks in the world.
Inflation factors into mortgage rates. Higher inflation and inflation expectations means higher mortgage rates, holding all else equal.
The demand for mortgages is to get a mortgage is another important factor.
Higher demand for mortgages will cause rates to go up.
Conversely, when there’s less demand to get a mortgage, fewer people are buying homes and this puts downward pressure on prices.
So how do you think about mortgage rates in the context of trying to predict the housing market?
It’s like any other asset class. Holding all else equal, lower mortgage rates mean higher prices while higher mortgage rates mean lower prices.
Building permits is a popular leading indicator for the housing market.
It is a measure of how many new homes are being built and can signal how strong future demand for housing will be.
Macroeconomic data on housing starts can give you some idea of where the market is going.
Housing starts is a measure of how many new homes are being built.
It is closely watched by analysts because it can signal how much future demand for housing there will be.
They provide a broad view of how the stock market is performing overall and within certain sectors. It can give a forward-looking indication of how confident traders, investors, and other market participants are in the economy.
If the stock prices of homebuilders are falling, it can signal that investors are becoming less confident in that sector of the economy and are cutting back on their investment in the housing market.
Lot sales is not something in which there’s popular existing macroeconomic data.
But lot sales can tell you something about a market because they represent land to be built on in the future.
Therefore, lots are a forward-looking thing that can give you insight on what developers think about a certain area.
If lot sales slow, you can probably expect the rest of the market to start slowing as well.
Builders’ confidence is another important factor to consider.
The National Association of Home Builders’ Housing Market Index is a good measure of builder confidence.
If builders are confident, they’re more likely to start new projects.
National Association of Home Builders – Prospective Buyer Traffic
The NAHB prospective buyer traffic is a measure of demand based on survey’s of homebuilders.
The index is a seasonally adjusted, weighted average of single-family builder responses to four key questions: traffic of prospective buyers, foot traffic of prospective buyers, internet lead traffic and sales contracts signed.
In order to be included in the NAHB prospective buyer traffic index, builders must be members of the National Association of Home Builders. The data is released on a monthly basis.
When it falls, there is less interest in buying and vice versa.
In short, there’s no one perfect way to predict the future of the housing market.
But by considering a variety of factors, you can get a pretty good idea of where the market is headed.
There are a number of indicators that analysts watch when trying to predict the housing market.
Lagging indicators, such as employment and home prices index, can give an indication of how the market has been performing.
Leading indicators, such as mortgage rates and building permits, can signal how strong future demand for housing will be.
Interest rates play a big role in affordability as they flow into mortgage rates and can therefore affect demand.
Stock indices, such as the XHB homebuilders ETF, provide a broad view of how the stock market is performing and can give an indication of how confident traders and investors are in the economy.
By watching all of these indicators, analysts can get a good idea of how the housing market is performing and how it is likely to perform in the future.
However, no single indicator is perfect and there is always some level of unknown when predicting the market.