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Monday, January 28, 2008

The Tragedy And Sorrow Of New Home Sales

You can get all the Census economic indicator releases at this page. New Home Sales for December is strikingly poor. The month-over-month SA drop of 4.7% is not statistically significant, but the bottom line is that I was hoping for a pop that did not appear. Revisions to this report have been consistently downward recently, so it's extremely doubtful that my expected pop will suddenly show up in a few months.

On a YoY basis, new home sales dropped 40.7%. The 90% confidence interval on that is 7.8%, so that is statistically significant and very negatively so. For all of 2007 compared to all of 2006, sales dropped 26.4%, so you can see that the rate of decline has accelerated sharply since late summer.

The reason this report upsets me is the following: Prime rates had dropped pretty sharply by December, and with the very high inventory of completed new homes and the extreme discounts available, it seemed possible to me that individuals would buy at the end of the year for tax reasons. The fact that they didn't is ominous. And jumbo loans are easy to get, and they are actually quite cheap if you have a downpayment. What is getting costly is the high CLTV jumbos. No one wants to get blindsided by jinglemail jumbos, and the only way to protect against that risk is either higher interest rates or significant downpayments.

Another disturbing aspect of this report is that completed homes in inventory keep rising, which mean that total new home inventory is still rising.

About the inventory of new homes:
Census tracks homes from authorization (permit) to first signed sales contract. Over the last few years, cancellations of those contracts have run wildly above historical standards. Therefore, the new home inventory as reported is quite understated. One cannot expect the beginnings of a rebound until about 12 months after inventory first begins to drop, so this is a very important leading economic indicator.

Instead of using the inventory reported on the new home sales report, we now have to use the inventory of completed homes available for sale at the end of the period. The reason for this is that completed new homes for sale compete with cancelled and no longer reported completed new homes for sale, and Census-tracked completed new homes and Census-dropped completed new homes should diminish at no less than the same rate. If anything, one would expect the older homes to be sold at bargain prices and thus move a bit quicker than the newer completions.

The cancellations largely occur when a home is completed but the putative owner refuses to or cannot close, so when the total of completed new homes available for sale drops over a period of a few months, we'll be pretty safe in claiming that we have reached the trough on inventory, and that within a period of 9-16 months (depending on the total level when we reach that point) residential home construction can be expected to rebound.

Here are the non-SA numbers of completed new homes available for sale:
Dec 06: 174,000
Jan 07: 177,000
Feb 07: 180,000
Mar 07: 181,000
Apr 07: 181,000
May 07: 182,000
Jun 07: 181,000
Jul 07: 181,000
Aug 07: 187,000
Sep 07: 191,000
Oct 07: 192,000
Nov 07: 193,000
Dec 07: 195,000

So on a YoY basis completed new homes for sale have risen about 12%. This is way outside of the uncertainty range. You can clearly see the impact of the credit crunch hitting in July, and the impact it had on new home sales. And you can clearly see that the situation is not improving. Even with diminishing building, the supply of completed homes for sale keeps rising. 7.8% of the rise in inventory occurred after July.

The median months for sale keeps rising, and that is another indicator of rising inventory. As for pricing, both median and averages are now plummeting.

So for the economy, we can pretty safely say that residential construction could not start to pick up again until late in 2009, at the earliest. There are now 11.9 months of supply on a non-SA basis, which probably equates to about 17 months of supply including the cancellations on an NSA basis, or over a year's worth of supply on an SA basis.

For finance, we can say that a lot of builders are fated to go bankrupt, and the regional banks are going to take a nasty hit from their loans related to residential construction.

In terms of existing home prices, the situation in the coastal bubble markets cannot improve until the aggregate of foreclosure/forced sale activity plus excess supply of new homes begins to reduce, and that would now seem to be pushed back until 2010 at the earliest in the western and southern bubble markets, and until after 2012 in the NE markets. Therefore prices of existing homes in the previously "hot" markets are doomed to drop at a faster rate in 2008 than they did in 2007.

For CRE, the small retail (think strip malls, etc) market is slated to go down for several more years, which will also have a disproportionately negative impact on a lot of regional banks. There is no bright aspect of this report.

We are looking at an absolute sea of red ink here. CR of Calculated Risk usually does a nice rich analysis of this release.

There is a high inventory of new homes here in KC, and drastic price reductions, below existing home prices... The problem for us (as would be homebuyers) is finding one that's well built! There is some seriously defunct construction here. Also, the fact that they continue to build takes away any confidence that prices will not plummet. If one were able to access honest information regarding their local economy and housing market, that might help. You have to wonder how bad it is that they can't tell you! Hope all is well with you and your loved ones, I look forward to this calming down so you can tell us a story!
Gayla, I have to agree about the construction. I think older houses are generally a better deal.

Stick with the rent/mortgage equation, and you'll do okay.
Mom,thank you.Here in Sonoma county ca we are just beginning to see the effect of REO's on the Market.The Banks were holding out for the old prices until very recently.I spoke to an appraiser today who is also seeing REO's selling for $100k less than the nearest comp.These are in solid developments in good areas,not mansions,but solid middle class neighborhoods.I called her to get her take on a rate term refi for someone who bought with 25% down in the summer of '06.no surprise,they will need to bring $15-25k to the table.
And MoM,OT again,I would not buy anything built during this boom in N cal unless it was built by a custom builder,and i looked real close.The quality is horrible,some counties actually allowed the builders to hire their own inspectors and it really shows...maintenance costs are going to be a lot higher for these structures.
Tom - thanks for the report. When it moves from the all-new developments to the established neighborhoods you know it is picking up momentum.

And I agree, the quality on a lot of recent construction is BAD. I just wouldn't want one of those houses.
The zero down mortgages of the last few years probably pulled a lot of future sales forward since people who wanted a home but didn't have the 20% down could get into the market. I think the high LTV ratios are going away for a long time, especially as losses on the loans made in the last few years mount. If you look at the (increased!) debtloads on the consumer, it is hard to see where the new folks with 20% down are going to come from, especially with the economy sliding into recession.

We are now trapped in a vicious cycle where weak housing and high debtloads lead to layoffs and reduced spending which leads to further reduced housing and further impaired debtloads. I don't see where we're going to get out of this cycle soon.
Couldn't have said it better, John. As to credit standards, I think we are creeping towards stability, but we have a long way to go to get there.

It's the draw-down on future demand that makes me uneasy.
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