Nouriel Roubini looked at the various stats released last week – the 16% increase in new home sales versus the 1.4% fall in home prices averaged across 32 metropolitan areas (Federal Housing Finance Board survey) and the 2.6% fall in existing home sales from March to April (National Association of Realtors) and focused on the outlier, the increase in new home sales. While other observers have used watered-down terms like “incentives” to describe the builder’s efforts to move product, Roubini says discounting and large ones at that. Moreover, given the size of the inventory overhang, he expect further price cuts.
Consider an additional factor not mentioned by Roubini: because subprime mortgages have become scarce, it’s a safe bet that the falloff in house sales is greatest in starter and other low-priced homes. That implies that the sales mix has probably shifted towards better homes. So that means, on a comparable house basis, that the price declines are like to be ever larger than the averages suggest.
Analysts who take the view that the worst of the housing recession is behind us took comfort from the news this past week that new home sales in April rose by 16% relative to their March level; also in April the stock on unsold new homes fell 538,000, a figure that is a little lower than the very large levels of the last six months.
Does this mean that the housing recession has bottomed out? The answer is no for two reasons. First, the new home sales figures are not rosy once one understands why such sales went up. Second, all of the other housing indicators of the week (existing home sales and inventories, Toll Brothers’ plunge of earnings and revenues, FHFB data on falling Q1 home prices) suggest continued and persistent weakness of the housing market and a deepening recession in this sector.
Let us start with the first point. An increase of 16% in new home sales looks huge until you notice the following points: new home sales are still 29% down from their July 2005 peak; the inventory figures for new homes exclude cancellations. We know that cancellations are massive, in the 20 to 30% range based on data provided by the two largest home builders in the US (DR Horton and Toll Brothers). Therefore, the actual stock of unsold new homes is much larger, at least 20% higher than the reported figures.
More importantly, new home sales surged in April but the median price of a home fell – in one month – by 11% to $229k. Now think about Economics 101: higher equilibrium sales and lower equilibrium prices. How can you get that? The answer is simple: the increase in sales cannot be driven by an exogenous increase in the demand for homes as such increase would have led to higher sales and higher prices. The only way you get higher sales and lower prices is if the home supply function – at any price level – has increased so that in equilibrium the excess of unsold homes leads to more demand at a lower price. I.e. the April data are consistent with only with the view that home builders – desperate with a massive and record stock of unsold new homes – decided to start slashing prices to reduce this overhang.
Is that good news? No for two reasons: first, the excess supply of new homes is still so large that only much lower home prices will dent this overhang; second, lower home prices means lower home equity and lower home wealth for homeowners.