New Home Sales in May fell by 2.1% from April, to a rate of 319,000. Relative to a year ago, sales are up 13.5%. While the rebound is more than welcome, it is still a very dismal rate of New Home sales.

Offsetting the decline was an upward revision to the April numbers of 3,000 to 326,000. Thus relative to where we thought we were, it could be seen as a 1.2% decrease. The May level was, however, substantially better than the expected rate of 305,000. Still, the 12 lowest months on record (back to 1963) for New Home Sales, have all been in the last year.

We are up nicely from a year ago, but that was against an “easy comp,” as sales were inflated by the rush to get in under the wire and collect the homebuyer tax credit in April of last year. Sales collapsed after that, and the May comp is thus an easy one. Relative to the peak of the housing bubble (7/05, 1.389 million) new home sales are down 77.0%.

The graph below shows the history of new homes sales (blue, left scale) along with the growth in population (red, right scale), since presumably if you have more people, you will need more places for them to live.

Take a very close look at the relationship between New Home Sales and the grey recession bars. New Home Sales fall sharply before all recessions (with the exception of the dot.com-bust-caused recession of 2001) and then start to increase sharply in the middle of, or towards the end of, the recession. That clearly is not happening this time around.

If you want to know why the recovery has been anemic so far, look no further than the graph above! New home sales are vital to the overall economy. If new homes are not selling, then home builders have no reason to build more of them. After all, that is very expensive inventory to sit on.

Unlike used home sales, each new home built creates a huge amount of economic activity. Not only are low new home sales bad for the big homebuilders like D.R. Horton (DHI), but also for all the companies that make the products and supplies that go into making a new house. They range from Berkshire Hathaway (BRK.B) for bricks, roofing materials and insulation to Fortune Brands (FO) for plumbing fixtures and cabinets to USG (USG) for wallboard to PPG Industries (PPG) for glass and paint.

In terms of employment, it is not just all the roofers and framers that lose jobs due to weak new home sales, but employees at all the firms that make the stuff that goes into making a new home. Of course, if those employees are out of work, they are not spending on other goods and services dragging down a host of seemingly unrelated businesses. Not that the direct impact of construction jobs should be underestimated. Since the recession started, one out of every four jobs lost has come from the construction industry.

Months of Supply

Inventories of new homes were down 3.5% on the month and are down 22.8% from a year ago. The months of supply is at 6.2 months, down from 6.3 months in April, from 9.2 months a year ago. That is well off the peak of 12.0 months, and is now just slightly above normal. A healthy market has about a six month supply of new houses and during the bubble, four months was the norm, as is shown in the graph below (from http://www.calculatedriskblog.com/).

Of course, used homes are very good substitutes for a new home, and last week we found out that the months of supply for used homes was 9.3 months, up from 9.0 months in April (see “Used Home Sales, Prices Fall”) That suggests downward pressure on existing home prices (and more foreclosure problems) which will continue to make life tough for the housing industry.

The absolute level of New Home Inventories is near a record low; near-normal months supply is entirely due to the low sales rate. Inventories of New Homes have now fallen for (at least) 29 straight months. Eventually population growth and a higher rate (more normal) of household formation will absorb the excess inventory.

Given the extremely low levels of new home starts, one does not have to imagine very high absolute levels to generate some very fancy looking percentage increases. The third graph, also from http://www.calculatedriskblog.com/), tracks the history of New Home Inventories. Note that inventories have declined at all three levels, not started, is basically improved lots. The biggest decline has come in homes under construction. The decline in the absolute level of inventories is good news, but is swamped by the still very high level of inventories of used homes.

Results by Region

Regionally, the numbers were very mixed. The numbers in the Northeast were dismal, with sales dropping 26.7% on the month and even down 18.5% from the easy comp of a year ago. The Northeast is, however, by far the smallest of the four regions and low absolute numbers can make for some pretty big percentage changes.

Relative to last month, sales in the West were down 3.5%, but they were up a sharp 31.7% from a year ago. In the Midwest, sales were unchanged from last month and up 5.0% from last year. The South, by far the largest of the four regions, was the only one with a monthly gain, up 2.4% as it was up 13.9% from last year.

An Improvement, but Still Bad

While this report was better than expected, and we also enjoyed a slight upward revision to last month, it was still an ugly report. The absolute level continues to be dismal. However, the price indicators were positive at least for the month. The median price of a new home rose 2.6% on the month and the average price rose 0.5%.

Relative to a year ago, things don’t look as good. The median (always lower than the average) is down 4.6% to $222,600, while the average price is down 5.2% to $266,400.

With the prices of used houses falling again, it makes selling a new home that much tougher. After all, a used home is a very good substitute for a new home. The housing sector has been a major drag on the economy for several years now. As Residential Investment is now a very small part of the overall economy (and new home construction is the largest part of, but not all of it), further drops in new home construction will not hurt the economy much going forward, but it sure would be nice to see it on the positive side of the ledger. That will happen eventually.

New home sales averaged 294,000 in the first quarter, so if the April and May can be maintained, the second quarter would be 9.7% above the first-quarter average. Granted, very low absolute numbers make any given percentage gain easier. Not much of a gain in absolute terms, but at least headed in the right direction.

Historically, on a non-seasonally adjusted basis, May is a slightly stronger month than April for New Home Sales. The unadjusted sales seem to be in line with historical norms (in terms of the month to month change, not the overall level).

The history or raw, unadjusted sales is shown in the next graph (also from http://www.calculatedriskblog.com/). Note the sharp decline from April to May last year, due to the tax credit effect, which is not in place this year.

Household Formation

The main problem right now for housing demand is the very low rate of household formation. Instead of moving out to get their own place, people in their 20’s are being forced to live with Mom and Dad, since they don’t have a job that will pay the rent or support a mortgage. Since residential investment is such an important swing factor in creating jobs in the country (both directly and indirectly) that sets up a huge “chicken and the egg” problem.

We are not in a robust recovery yet, but the seeds have been planted. It is unlikely that they will germinate this summer, and it may take longer than that, but eventually they will sprout.

The lack of a housing recovery is the key difference between this recovery and every other one which has preceded it. The collapse of the housing sector is directly responsible for a quarter of the jobs lost, and indirectly responsible for many more than that. The loss of jobs has, in turn, depressed household formation, and thus further depressed the housing market.

Even extremely low mortgage rates have not been enough to get things going again. We still have extremely high vacancy rates, both of apartments and of houses sitting empty, although lately we have seen some improvement in the rental market.

Until that excess is absorbed, it is unlikely that we will get anything like a robust housing sector, although even a tripling of the New Home Sales rate from current levels would bring us to what was considered a normal rate of sales back in the 1970’s and 1980’s. Back then we had far fewer people, and thus a lower need for places for people to live. Like a kidney stone, this too shall pass.

Overall, I would have to count this report though as mixed, as it was better than expected but still down on the month and also at a dismal absolute level. The absolute decline in the level of inventory has been impressive. I’m not going to get giddy anytime soon though. We might be starting down the path towards a recovery in the housing sector, but it is likely to be a long and difficult road before we reach our destination.
 
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