New Home Sales fell by 12.4% in July to a seasonally adjusted annual rate of just 276,000. That is a new record low for the data that stretches all the way back to the early 1960’s.
The previous record low had been set in May at 281,000. Relative to a year ago, sales are down 32.4% from a 408,000 annual pace. And a year ago was not exactly the best of time for the nation’s homebuilders. The peak of new home sales during the housing bubble was a 1.389 annual rate set in July 2005, so we are down over 80% from the peak.
The revisions to prior months were, on balance, a wash. The June pace was revised down from a 330,000 pace to just 315,000. May, on the other hand, was revised up from 267,000 to a 281,000 pace.
Inventories were flat relative to June at 210,000, but that is down 25.0% from the 270,000 new houses that were on the market a year ago. Builders have done a good job in controlling their inventories, but they have not been able to ramp things down as fast as sales have deteriorated. The months of supply shot up to 9.1 months from 8.0 months in June, and from 7.9 months a year ago.
That is not a comfortable position for the home builders to be in. This is, after all, very expensive inventory to carry on your balance sheet. Of course, in this environment, controlling your inventory simply means building fewer houses.
In addition to building fewer houses, it looks like they are building smaller houses as well, or at least less expensive homes. The median price for a new home fell 6.0% on the month to $204,000 and is down 4.8% from a year ago. The average price fell 5.2% to $235,300 and is down 13.2% from a year ago.
Bad News by Region
Part of the decline in the average price can be traced to the regional variation in how fast new home sales are dropping. Worst hit by far this month was the West, where sales plunged 24.4% for the month and are off 54.6% year over year. Next worst hit was the Northeast, with a 13.9% decline for the month and off 24.2% year over year.
Housing tends to be most expensive in the Northeast and West, and relatively cheap in the Midwest and South. Sales fell “only” 8.3% in the Midwest for the month, and are down 21.4% year over year. Sales in the South were down 8.7% from June and down 26.6% from a year ago.
Not all the regions though have equal importance. The South is by far the biggest, and thus the most important. In July, 56.9% of all new home sales were in the South and just 11.2% were in the Northeast.
Can’t Blame the Tax Credit
New home sales are recorded when the contract is signed, not at closing, as is the case with existing home sales. Thus the immediate hangover from the end of the homebuyer tax credit was felt in May, and we should be getting over that effect by now. This was just plain a dismal number and one that really cannot be explained away by special factors.
The Economic Impact of New Home Sales
It is hard to overstate just how important new home sales are to the overall economy. Look at the graph below (from http://www.calculatedriskblog.com/) and you will see why. Each new home built generates a huge amount of economic activity.
It is not just the homebuilders like D.R. Horton (DHI) that are affected. For starters, think of the amount of material that goes into building a house. Each house uses a lot of lumber from the likes of Weyerhaeuser (WY). To build a new house you need sheet rock from USG (USG) and plumbing fixtures from firms like Fortune Brands (FO).
Thus when houses get built, it is not just the carpenters, electricians and roofers that go to work, but that work also leads to lots of jobs for lumberjacks, as well as many factory jobs. Given that building supplies tend to be heavy, most of them are still made here in the U.S. rather than imported.
Existing home sales, by comparison, generate almost no new economic activity, and are only important in so far as they give clues to the future direction of housing prices. As the principal store of wealth for most Americans, the value of existing homes is vitally important. The level of turnover is significant only in relation to the number of houses that are up for sale. Yesterday, the news on that front was just plain awful (see “Home Sales Plunge, Prices to Follow”).
Interest Rates Not Doing the Trick
Demand for housing is normally exquisitely interest-rate sensitive. Thus when the Fed thinks that the economy is overheating it will raise interest rates, and that will slow down demand for new houses. When the economy falls into a recession the Fed slashes rates, and thus housing revives. Note how new home sales tend to fall sharply just before the economy falls into recession, and at the sharp rebound that normally occurs during or right at the end of a recession.
The economic activity from building new homes (which of course must be sold rather than just sit in inventory if it is going to be sustainable) is like the starter motor on the engine of the economy. The people who are working as framers and roofers have the money to go out and spend on other things; this helps retail sales and things like restaurants. Then those workers then go out and spend money and we get into a self-sustaining cycle.
Construction workers have been particularly hard hit in this downturn, accounting for more than a quarter of all jobs lost, even though before the recession started they accounted for less than 6% of all the jobs in the country.
But this strategy just is not working this time around. In July, mortgage rates fell to 4.56%, down from 4.74% in June and 5.22% a year ago. Still, new home sales are lower than they were when Paul Volcker hiked interest rates sky high in the early 1980’s and mortgage rates were in the high teens.
Quite frankly we simply built far too many new homes during the bubble years. Since housing is sort of the ultimate durable good, it means we are still working off those excesses. Of course, without those excess homes being built, there would have been virtually no recovery at all from the 2001 recession.
Tax Cuts Haven’t Helped
Unless you can make the case that the 2001 and 2003 tax cuts were responsible for a huge boom in building new houses, one has to conclude that they were a remarkably ineffective way of helping out the economy. By contrast, the ARRA (aka the Stimulus Act) has, according to the non-partisan CBO, raised GDP in the second quarter by at least 1.7% over what it would have otherwise been, and perhaps improved it by as much as 4.5%. In terms of jobs, it has increased payroll employment by between 1.4 and 3.3 million.
Letting the Bush tax cuts — particularly those on the very highest earners in the country — expire, and using some of that money for more stimulus activity, would greatly help the overall economy. High on the list of priorities would be to help out the state and local governments so they don’t have to drastically cut back services or raise taxes.
The sorts of taxes that state and local governments are likely to raise, namely property and sales taxes, would be a much bigger drag on the economy than raising the rate for those earning more than $400,000 to 39.6% from 35.0%. If state and local governments cut spending rather than raise taxes, then they would be laying off teachers, cops, social workers and firefighters, and that will obviously directly cause unemployment to rise.
There is also lots of infrastructure in the country that is crumbling and needs to be repaired or replaced. While we have all this slack in the economy, now would be a great time to get around to doing it.
Very Negative Report
This was a very negative report, and it is serious evidence that the economy is slowing very rapidly. It significantly raises the odds that third quarter GDP growth will be negative. Unlike the existing home sales report yesterday, this cannot simply be attributed to the immediate hangover from the end of the tax credit. That effect happened months ago.
This is just a reflection of very poor underlying demand for houses and to the massive oversupply of existing homes (12.5 month supply) for sale. After all, an existing home is a pretty good substitute for a new home.
Demand for housing is low in large part because the rate of household formation is very low. In other words, kids are not moving out from Mom and Dad’s house the way they used to. The reason they are not moving out is because they don’t have jobs and thus can’t afford to.
In an economic recovery, construction normally provides a lot of the incremental new jobs, particularly for those that don’t have a lot of formal education. Thus housing will not improve until employment improves, and employment will have a hard time improving if housing does not improve. Chicken, meet egg; egg, say hello to chicken.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
D R HORTON INC (DHI): Free Stock Analysis Report
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