Existing Home Sales Dip in May: When Will Real Estate Market Stabilize?

Existing home sales unexpectedly fell 2.2% in May to a 5.66 million unit annualized rate, but the overriding question in the real estate market remains the same: When will housing inventories return to normal levels?

Although inventories, which fell 3.4% to 3.89 million units in May to an 8.3-month supply, are down 14.9% from the record 4.58-million-unit peak reached in July 2008, they're still roughly double their 30-year average, about 2 million units.

Assuming the current sales pace holds, it will take about six months for inventories to return to the normal three- to four-month supply -- longer, if sales decline in the months ahead. The return to a normal level of inventory will be vital to stabilizing home prices, and will, hopefully, be followed by the eventual return of healthy annual appreciation rates in the range of 4% to 7%.

Where AreExisting Home Sales Headed?

Can existing home sales maintain their current pace? The key factor, now that the home buyer tax credits have expired, will be the employment rate. Job growth leads to an increase in household formation: If the U.S. economy adds 150,000 to 200,000 jobs per month, that should create enough new households to keep existing home sales at or near current levels.

But for now, job growth remains a question mark. After creating about 208,000 and 290,000 jobs in March and April, respectively, the economy stumbled in May, when fewer than 50,000 private sector jobs were created. If the May jobs data represents merely a pause in hiring, household formation should be adequate to maintain the current sales pace. If it's the sign of a larger, more profound slowdown, sales will decline in tandem with the economy.

The final piece of the existing-sales puzzle is mortgage availability. Interest rates for 30-year fixed-rate mortgages are at or near record lows, but mortgage qualification requirements remain high. The days of "no money down, 100% financing" are a distant memory. A 10% down payment is the norm again, and some banks are requiring borrowers to have even more "skin in the game." Beyond that, income history and job security filters are weeding out a large portion of prospective home buyers, people who could have qualified for a mortgage during the housing bubble, but wouldn't today.

Assuming Congress does not extend the home buyer tax credit for a second time, it will primarily be the health of the U.S. economy and the credit markets that dictates the future arc of existing home sales and inventories. An economic recovery with impressive job growth and normal credit conditions could be expected to churn through the excess housing supply in less than a year. But if the nation experiences a sluggish economy with tepid growth and constrained credit conditions, the likely result will be declining sales, continued high inventories, and downward pressure on home prices.