By Dirk van Dijk, CFA
New home sales in August were unchanged from July at a dismal rate of 288,000. The only good news is that July was just slightly less bad than we thought it was last month, and was revised up from 276,000. That means that July is no longer the worst month on record (back to 1963) for new home sales -- that dubious honor reverts back to May.
Relative to a year ago, sales are down 28.9%. It is not like a year ago was a great time in the homebuilding industry, either. Relative to the peak of the housing bubble (7/05), new home sales are down 79.3%. The very low May sales rate (282,000) was due to the end of the homebuyer tax credit. New home sales are recorded when the contract is signed, not at closing as is the case with used home sales. Thus the post tax credit hangover came in May for new home sales, not July as was the case for existing home sales.
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.
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 (NYSE: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 ((NYSE:BRK.B), bricks, roofing materials and insulation) to Fortune Brands ((FO), plumbing fixtures and cabinets) to USG ((NYSE:USG), wallboard) to PPG Industries ((NYSE:PPG), glass and paint) to International Paper ((NYSE:IP), lumber).
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 then 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.
Inventories of new homes declined by 1.4% on the month and are down 21.4% from a year ago. That puts the months of supply at 8.6 months, down from 8.7 months in July, but up from 7.8 months a year ago. While that is well off the peak of 12.0 months, it is still well above normal. A healthy market has about a six-month supply of new houses (during the bubble, four months was the norm). Of course, used homes are very good substitutes for a new home, and yesterday we found out that the months of supply for used homes was 11.6 months (see "Used Home Sales Rebound Slightly"). That means that prices of existing homes are going to continue to fall, making life even tougher.
Regionally, things were all over the map. New home sales in the West actually soared 54.3% on the month but are down 33.6% year over year. The Northeast was also healthy with a 16.7% increase on the month, and down just 5.4% year over year. The Northeast is, however, the smallest and least significant of the four census regions when it comes to housing data. Even with the increase the Northeast accounted for just 12.2% of all sales, up from 10.4% in July and 9.1% a year ago.
Sales in the South, which is the biggest of the four regions by a wide margin, fell 10.4% on the month and are down 28.2% year over year. In August, the South was responsible for 51.4% of all new home sales, down from 57.6% in July but up from 50.9% a year ago. Sales in the Midwest collapsed 26.1% on the month and are down 38.2% year over year.
Overall, this was a very depressing report, although it not much below the consensus expectations of a 291,000 pace. The upward revision to the July numbers more than makes up for that miss.
Eventually, we will see a recovery in new home sales and thus homebuilding. However, first we have to clear out all the existing inventory overhang of both new and existing homes. That includes the shadow inventory of homes that have been foreclosed upon -- or are about to be -- but which are not yet listed for sale. That remains a daunting task.
On the other hand, a doubling in new home sales would bring us back to approximately the same level of sales we average in 1964 when the population was just 191 million, relative to today’s population of 310 million. When -- not if, but when -- that happens, the economy will be set to boom.
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 20s 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 egg" problem. We are not in a robust recovery yet, but the seeds have been planted. It is unlikely that they will germinate before next spring -- and it may take longer than that -- but eventually they will sprout.
Disclosure: No positions