The National Association of Realtors (NAR) seasonally adjusted pending home sales index for September 2014 improved - and is finally back in expansion after a year in contraction. Our analysis of pending home sales however suggests that October 2014 existing home sales will be much better than September's but still will be in contraction year-over-year.

Pending home sales are based on contract signings, and existing home sales are based on the execution of the contract (contract closing).

The NAR reported:

• Pending home sales index was up 0.3% month-over-month and up 1.0% year-over-year.
• The market was expecting month-over-month growth of -1.0% to 2.0% (consensus 0.8%) versus the growth of 0.3% reported.

Econintersect‘s evaluation of the unadjusted data shows:

• the index growth accelerated 7.1% month-over-month and up 3.0% year-over-year.
• The current trends (using 3 month rolling averages) improved - but continue to be in contraction.
• Extrapolating the unadjusted data to project October 2014 existing home sales, this would be a 2.5% contraction year-over-year for existing home sales. Although this seems strange the pending index would be positive whilst the forecast is negative - it is caused by a correction factor for seasonal error.
• After 28 months of year-over-year growth followed by 11 months of contraction, pending home sales according to the unadjusted data has finally moved into expansion territory this month.

Unadjusted 3 Month Rolling Average of Year-over-Year Growth for Pending Home Sales (blue line) and Existing Home Sales (red line)

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From Lawrence Yun , NAR chief economist:

.... moderating price growth and sustained inventory levels are keeping conditions favorable for buyers. Housing supply for existing homes was up in September 6 percent from a year ago, which is preventing prices from rising at the accelerated clip seen earlier this year. Additionally, the current spectacularly low mortgage rates should help more buyers reach the market.

.... the final rule on Qualified Residential Mortgages should improve access to credit once it goes into effect next year. The rule provides clarity for lenders and is a win for creditworthy consumers by ensuring they continue to have access to safe and affordable loan products without overly burdensome downpayment requirements,

The National Association of Realtors (NAR) pending home sales index offers a window into predicting existing home sales. The actual home sale might appear in the month the contract was signed (cash buyers can close quickly), or in the following two months.

Econintersect forecasts unadjusted existing home sales by offsetting the pending home sales index one month. This forecast suggests unadjusted existing home sales of 415,000 in October 2014 (a negative 35,000 fudge factor this month for historical error using this methodology for the month of Octobers in years past).

Using Pending Home Sales to Predict Existing Homes Sales – Unadjusted Existing Home Sales (blue line) & Predictive Forecast Using Pending Home Sales Index (red line)

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Using this methodology, 392,000 existing home unadjusted sales were forecast for September 2014 (with a negative 26,000 fudge factor) versus the actual reported number of 435,000 (which is subject to further revision).

Unadjusted Year-over-Year Change in Existing Home Sales Volumes (blue line), 3 month rolling average (red line)

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As shown on the above graphic, since mid 2011 home sales have been positively growing year-over-year. However, Since November 2013 home sales showed a contraction year-over-year for the first time since 2011.

Keeping things real – home sales volumes are only 2/3rds of previous levels.

Caveats on the Use of Pending Home Sales Index

According to the NAR:

NAR’s Pending Home Sales Index (PHSI) is released during the first week of each month. It is designed to be a leading indicator of housing activity.

The index measures housing contract activity. It is based on signed real estate contracts for existing single-family homes, condos and co-ops. A signed contract is not counted as a sale until the transaction closes. Modeling for the PHSI looks at the monthly relationship between existing-home sale contracts and transaction closings over the last four years.

…… 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.

NAR now collects pending home sales data from MLSs and large brokers. Altogether, we receive data from over 100 MLSs & 60 large brokers, giving us a large sample size covering 50% of the EHS sample. This is equal to 20 percent of all transactions.

In other words, Pending Home Sales is an extrapolation of a sample equal to 20% of the whole. Econintersect uses Pending Home Index to forecast future existing home sales.

Econintersect reset the forecasting of existing home sales using the pending home sales index coincident with November 2011 Pending home sales analysis (see here) – as the NAR in November revised the historical existing home sales data.

The Econintersect forecasting methodology is influenced by the speed at which closings occur. When they slow down in a particular period – this method overestimates. The number of cash buyers are speeding up the process (cash buyers analysis here). A quick cash home sale process could begin and end in the same month. On the other hand, contracts for short sales can sometimes take months to close. Interpreting the pending home sales data is complicated by weighing offsetting effects in the current abnormal market.

Please note that Econintersect uses unadjusted data in its analysis.

Econintersect determines the month-over-month change by subtracting the current month’s year-over-year change from the previous month’s year-over-year change. This is the best of the bad options available to determine month-over-month trends – as the preferred methodology would be to use multi-year data (but the New Normal effects and the Great Recession distort historical data).