Tuesday new home sales report missed expectations and had negative reviews, which is not surprising given that this sector of our economy simply cannot sustain higher mortgage rates. The housing market is in a recession, which homebuilders and National Association of Realtors now agree with me, like this recent CNBC clip shows.
This means that builders are done building new single-family homes until they are sure they can get rid of their 10.9 months orderly supply. This could happen if lower rates stimulate demand, but today the 10-year yield is still at 3%. So for now, builders will take their time with homes under construction and make sure they offer enough incentive to offload the supply of new homes they are dealing with.
Of Census: Sales of new single-family homes in July 2022 came in at a seasonally-adjusted annual rate of 511,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 12.6% (±16.9%)* lower than the revised June rate of 585,000 and 29.6% (±10.9%) lower than the July 2021 estimate of 726,000 .
Over the years I’ve tried to point out that the US housing market cannot have a credit sales boom like we saw from 2002 to 2005. That means we won’t be working from from record high sales demand like we did at the peak of 2005. After all, sales levels are already historically low for new homes. Tuesday’s new home sales report only shows 511,000 new homes sold. This figure is below levels from the 2000 recession and is back to 1996 levels.
Builders are in a better position to manage their inventory glut than when working from a credit boom in 2005 that sent new home sales soaring to 1.4 million, with a significant oversupply of single-family homes relative to the natural demand curve for new home sales.
After peaking in 2005, new home sales fell 82% from peak to peak, then saw the weakest housing recovery in the next expansion. We had missed sales estimates in 2013, 2014 and 2015. Additionally, we had a supply spike in 2018, which caused builders to halt construction – and that was with rates that were only reaching than 5%. Today, rates close to 6% are simply too high for the product they are selling to the public.
From the census: The seasonally adjusted estimate of new homes for sale at the end of July was 464,000. That represents a 10.9 month supply at the current sales rate.
You read correctly : 10.9 months! We are almost back to the level of the monthly supply at the height of the collapse of the real estate bubble! Does that mean the massive supply will hit the market any second?
No, it’s a different story this time. First, we have not had the same production of housing supply as during the years of the housing bubble, mainly driven by single-family housing. This time we have less house production and more multi-family construction.
Also, because the housing completion data has been so bad over the past few years, it takes forever to complete these homes. This means that we have a lot of houses under construction or that have not even started. The numbers are historic.
- 1.06 month of the offer are finished products
- 7.33 month of the offer are under construction
- 2.51 months supply hasn’t even started yet
My rule of thumb for anticipating the behavior of manufacturers is based on the average supply over three months:
- When the supply is 4.3 months and below that is a great market for builders.
- When the bid is 4.4 to 6.4 months, it is only a good market for builders. They will build as long as new home sales increase.
- The builders will withdraw from construction when the offer is 6.5 months and above.
The homebuilding cycle is over, but builders will finish their homes under contract and hope rates will soon drop to lock in buyers. Then they’ll get busy building more single-family homes, and if rates stay high, it’ll be interesting to see what happens. If rates fall back towards 4%, the real estate landscape will change.
Of Census: The median selling price for new homes sold in July 2022 was $439,400. The average sale price was $546,800.
With housing post 2020, home sellers and home builders had a lot of pricing power and pushed it onto the consumer because they could. It was very different from the previous expansion.
Now the trick for builders is to figure out how much they need to cut to entice buyers to buy the homes under construction. It’s more complicated with mortgage rates close to 6% than with mortgage rates close to 4%. However, it was on them – they had pricing power, and just like door-to-door sellers in America, they pushed him to make big bucks in the short term.
The consequence of the higher rates is that homebuilders’ confidence in selling homes to make money has plummeted. When I raised my fifth housing-related recession red flag in June, it was before the big crash in homebuilder sentiment.
As you can see below, this confidence index has recently taken a cascading plunge, which shouldn’t be too surprising given how quickly rates have risen on builders.
Overall, this is not a shocking report. This year, the housing market has entered a recession associated with more traditional recessionary realities. Home sales plummet, production plummets, and industry revenues plummet. We have seen job losses in the mortgage and real estate sector, but not yet in the construction labor sector, as they have to complete many houses under construction and those which they do not have started yet.
It’s very different from the boom and bust of real estate credit leverage in 2005, but it’s still a real estate recession.