Bill Testa and Norman Wang
Throughout the Great Recession and the first few years of the subsequent economic expansion, the markets for homes and related building activity failed to contribute to national and regional growth. In fact, over the calendar years 2008–10, residential investment subtracted from overall U.S. economic activity at an average pace of 1 percent. More recently, however, residential real estate markets have begun to recover in many areas of the Seventh Federal Reserve District and the United States. House prices and sales have firmed, and the pace of new home construction has picked up, albeit up from very low levels.
In an effort to analyze residential real estate market developments in the Seventh District, we have developed an index that monitors its 54 metropolitan areas. This index is built from two distinct data measures of housing market activity in each metropolitan area. The first measure is residential building permits. Permits are obtained prior to the construction of both single-family homes and multi-family buildings, such as apartments and condos; and data on the issuance of these permits are collected on a monthly basis. The second measure is the Federal Housing Finance Agency’s House Price Index (HPI), which is a quarterly measure that tracks the movement of single-family house prices. A weighted repeat-sales index, the HPI reports the average house price changes as obtained from records of new mortgages and mortgage refinancings on the same single-family properties. By looking at both permits and HPI data for multiple metro areas in the Midwest, we can find broad directional trends in residential real estate in the Seventh District.
By examining the readings of the two measures (residential building permits and HPI) for many individual localities, we may be able to soon see the beginnings a broad-based housing recovery in the Seventh District. The overbuilding that took place before the 2008–09 recession varied in degree and timing across the Seventh District. Given this variation, we might not expect our metropolitan areas to reach bottom at the same time. And so, our compilation of these data on metropolitan areas may be telling of the Seventh District’s overall progress (or lack thereof) with regard to housing.
To derive additional information from these data, we combine them using what is commonly called a diffusion index. In constructing the index, we first record each metropolitan area’s readings of both residential building permits and house prices (according to the HPI) as a direction (rather than a degree) of change—that is, we record them as “up,” “down,” or “no change.” Next, we combine each metropolitan area’s readings of building permits and house prices into a single observation for each time period. More specifically, we count a metro area as a positive observation (indicating expansion) only if both indicators are up year over year. If both indicators are down year over year for a metro area, we count it as a negative observation (indicating contraction). Otherwise, if one indicator is up on a year-over-year basis while the other is down (or if either indicates no change), we record the metro area as a neutral observation (indicating no change or no conclusive direction). Further, all the metro area observations are then combined into an overall index indicating the breadth of the direction (either expansion or contraction). So, if all metro area observations were recorded as positive, the index value would measure 100, indicating expansion. And if all metro area observations were recorded as negative, the index value would measure zero, indicating contraction. Finally, if one half the observations were recorded as positive while the other half were recorded as negative, the index would yield a value of 50, indicating that the Seventh District’s residential real estate sector was, on the whole, neither expanding nor contracting. Accordingly, any index value greater than 50 (indicating that more observations are positive than negative) signals expansion for the Seventh District’s residential real estate sector.
The map of Seventh District states below shows the observations during the first quarter of 2006—a time of transition for many residential real estate markets across the nation and within the Seventh District. Those metropolitan areas shaded in red were experiencing declines in both building permits and prices of existing homes (on a year-over-year basis), while those shaded in green were still experiencing growth in both measures. The unshaded metropolitan areas were experiencing a decline in one measure with growth in the other.
Chicago Fed Housing Market Index Readings and Seventh District, 2006:Q1
Our housing index combines such observations into a single index value for each quarter. To help illustrate how we derive this quarterly value, we developed the chart below. This chart plots the total number of positive (or expansionary) observations of metro areas for every quarter from late 1988 through early 2013, as well as the total number of negative (or contractionary) ones over this span. Throughout the 1990s and the first half of the 2000s, it is seen that expanding residential market activities were widespread within the Seventh District (blue line). Moreover, that time period features many quarters when there were no contracting residential real estate markets in the Seventh District’s metropolitan areas (red line). A dramatic reversal began to take place during 2005, which is evident in the chart.
Our index combines these observations of individual metropolitan markets by simple subtraction. The difference in each quarter of the metropolitan areas with expanding residential real estate markets minus those with contracting ones is determined and then set to a base index value of 50. A chart of our Housing Market Index (below) displays the breadth of the expansion in residential markets before 2006. Since 2006, contractionary residential markets have largely been the norm across the Seventh District. Very recently, however, our index shows that residential markets are stabilizing in many of the Seventh District’s metropolitan areas. Moreover, an important benchmark (the index value of 50) has been breached during the first quarter of 2013; finally, the overall balance has tilted toward broad expansion in the District’s residential real estate sector—for the first time since late 2005.
To supplement the overall index, we have provided another mapping of our metropolitan area observations—this one for the first quarter of 2013. In general, such a display may also allow us to see any geographic patterns of recovery in residential real estate markets that relate to underlying economic trends—such as agriculture booms that are lifting the economies of small metro areas, service-sector-led economic growth in large metro areas, or automotive production recovery that is contributing to the economic growth of certain parts of the Seventh District with historical ties to the automotive industry.
Chicago Fed Housing Market Index Readings and Seventh District, 2013: First Quarter
Those of our readers placing too much confidence in the recent uptick in our index may do well to remember that it has been widely posited that the ongoing housing recovery is likely to experience many fits and starts. Formal inventories of housing that is available and listed for sale are currently tight. However, it is the large latent or potential supply of homes that can come onto the market with uncertain timing and amounts that may give rise to future market volatility. Included among such potential supplies are those homes that are unavailable because they are undergoing legal proceedings of foreclosure, or those that are temporarily owned by banks that have taken possession in default situations. Still other homes are delinquent in mortgage payments and that could ultimately fall into a foreclosure process. Presumably, most of these home owners cannot sell the properties at a price that would allow them to cover the existing mortgage and liens. And so, such properties are not listed for sale (i.e. they are not a part of the formal inventory).
The chart below illustrates the stock of homes that are either in foreclosure or that are delinquent in mortgage payments. This potential inventory has been falling rapidly in the Seventh District states, yet it remains far higher than historic levels in the late 1980s through the early 2000s.
Note: The levels above are made up of homes having delinquent mortgages plus other homes that are undergoing foreclosure. Inventory of mortgages in foreclosure refers to the total number of loans in the legal process of foreclosures started during the quarter. Some foreclosures included in a quarter have been started but have yet to be resolved.
Source: Haver Analytics/Mortgage Bankers Association.
In a similar vein, although existing home prices have recently been on the rise, many non-delinquent homeowners retain a mortgage whose liability value exceeds the expected sales price of the home on today’s market. An unknown number of such owners are unable or unwilling to list them for sale at the present time (despite their desire to move away) but they will possibly do so if home prices continue to climb. And so, such homes represent yet another potential housing supply that may arise as home sales (and prices) continue to improve. The chart below suggests that such home owner situations persist in some of the District’s large metropolitan areas.
Source: Haver Analytics/Zillow.
It is clear that there are many crosscurrents afoot in housing markets. Our diffusion index will be a helpful way to observe how they are playing out across the Seventh District.
 Residential investment’s contribution to overall U.S. economic activity is measured in terms of real gross domestic product (GDP) growth at an annual pace, averaged over annualized quarters. (Return to text)
 The two data variables used to construct the quarterly index are measured as: (1) percent change in year over year (by month) residential permits, averaged within each quarter, and (2) percent change in year over year house price index (by quarter). The house price data are stated in real terms deflated by the national “core” PCE less food and energy (personal consumption expenditure deflator) as estimated and reported by the Bureau of Economic Analysis. (Return to text)
 The index is constructed as [(# MSAs observed) + (# of MSAs for which HPI is greater than one and for which permits is greater than one) – (# of MSAs for which HPI is less than one and for which permits is less than one)] / [2 x (# MSAs observed)]. (Return to text)