The shockingly low rate of New Home Sales in July needs to be put into context (see "Worst New Home Sales EVER!"). The only problem is that the context only makes things seem worse than the raw numbers do.
The 276,000 annual rate of New Home Sales was the lowest on record, and the record goes back to the start of 1963. At the start of 1963, the population of the country was 188.1 million; in July 2010 it is estimated to be 310.2 million -- an increase of 64.9%. More people should mean more need for places for people to live. Of course, not everyone lives in a new house, but existing houses make pretty good substitutes. Still, there should be a relationship.
The graph below shows the number of new houses sold (Seasonally Adjusted Annual Rate) per 100 people in the county. In July, we slipped below the 1 new house per 100 people for only the second time in history, the first time being in May. The July reading was an all-time low at 0.90. That is 80.8% below the all-time high set in July 2005 of 4.69.
While there is clearly a cyclical variation, the series does seem to have a very strong mean reversion tendency to it. On average, there have been 2.88 new homes sold per 100 people in the country since 1963. For two thirds of the months on record, sales would be between 3.45 per 100 people and 2.10 per 100.
Falling below 2.0 was very rare -- it only happened in 30 of the 540 months between January 1963 and January 2008. It has been below that level in the 35 months since then. Similarly, there is no instance of sales exceeding 4 per 100 prior to June 2003, but it happened 24 times in the 30 months between then and December 2005 (inclusive).
There was no particular demographic reason for sales to spike in the middle part of the last decade. The big bulge in the late 1970’s happened to coincide with the Baby Boomers moving into the prime age of buying a first house, their late 20’s. New houses had to be built and sold to accommodate the twenty-somethings moving into a place of their own. Even if they themselves bought an existing house, the people they bought from would need a new place. Eventually that shows up in new construction.
In addition to demographics, the other big historical factor in determining the level of new home sales has been the mortgage rate. The second graph shows the level of new home sales versus the rate on a 30 mortgage (I had to string two data series together to get rates for the whole period, but they have a long overlap and seem to track each other very closely.
Prior to the great housing collapse of the past few years, almost all of the previous instances of sales falling below 2 per 100 were due to sharp spikes in mortgage rates. That happened most dramatically when mortgage rates were pushed to 18% in the effort to break the back of inflation.
This time around, mortgage rates were clearly not the problem. They did not spike very much prior to the collapse in home sales, and record low rates have not done anything to help them rebound. Rather, the problem is that so many new homes were built and sold during the bubble, that several years' worth of demand were pulled forward.
The population of the country continues to grow, and eventually the overhang will get worked off. In the past, the ratio of new homes sold to population has shown a very strong tendency to return to the long-term average. However, the level can be above or below that level (2.77) for several years at a time.
Just returning to the long-term average level would lead to more than a tripling of new home sales. Given that each new home built and sold generates an enormous amount of economic activity, that reversion to the mean holds the seeds of a very big economic boom in the future.
As construction workers go back to work, they will have more money to spend, and as they do, it will stimulate employment in a whole array of other industries. Right now, with so many of them out of work for extended periods of time, it is a pretty good bet that they are not going out to eat much at anywhere other than McDonald's (MCD), and there not all that often.
As they start working again, they might splurge more often by going out to eat at Red Lobster or the Olive Garden (both owned by Darden, DRI). That will mean more jobs for cooks and waiters. They, then, will have more money to spend at Wal-Mart (WMT), which in turn will mean more jobs for greeters and cashiers.
New homes also consume very large amounts of building products, leading to more revenues and employment in the lumber, sheetrock and roofing industries. As more people are employed, the rate of household formation will increase. In other words, grown kids will move out of Mom’s basement and into a place of their own. That will, in turn, drive up demand for more housing. A self-reinforcing positive cycle will be under way.
Upturn a Ways Off
An upturn in housing will come, but it is not coming very soon. The drop in housing values has left almost one in four homeowners with mortgages with home values that are less than the amount of the mortgage. The farther underwater a homeowner is, the more likely the home is to go into foreclosure. For many underwater homeowners, walking away and not paying the mortgage is by far the most rational economic decision they can make.
The continuing flood of foreclosed properties is going to be tough competition for the home builders like D.R. Horton (DHI). According to a recent report by First American Core Logic, 11 million homes are now underwater, or 23% of all homes with mortgages on them. In addition, another 2.4 million have less than 5% positive equity (which given realtors fees and other closing costs would effectively put them underwater if they tried to sell today). Together, the underwater and those with their heads just above the waves make up 28% of all houses with mortgages (about 30% of all homes are owned free and clear).
As the third graph below shows, there is significant regional variation in the “home flooding.” Ironically, the worst of these floods are in the desert. In Nevada, 68% of all homes are already underwater, while in Arizona half of all houses are underwater. (Why they are trying so hard to lower their population with draconian anti-immigration legislation is a bit of a mystery, in this context. It will simply mean fewer people there and thus lower demand for housing and thus lower home values.)
With the current supply of existing houses for sale at a record high relative to the sales pace of existing homes at 12.5 months, it seems abundantly clear that the direction of existing home prices is down over the next year or so. Since houses are much more affordable now than they were a few years ago, we are not going to see another 30% decline, though a decline of 10% is very possible. As that happens, all the people in the red portion of the bars will move into the blue part of the bars, and new people will find themselves just above the waves.
When the new housing cycle takes hold, the economy is likely to boom. Unfortunately, that is not going to happen anytime soon.
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The graph below shows the number of new houses sold (Seasonally Adjusted Annual Rate) per 100 people in the county. In July, we slipped below the 1 new house per 100 people for only the second time in history, the first time being in May. The July reading was an all-time low at 0.90. That is 80.8% below the all-time high set in July 2005 of 4.69.
While there is clearly a cyclical variation, the series does seem to have a very strong mean reversion tendency to it. On average, there have been 2.88 new homes sold per 100 people in the country since 1963. For two thirds of the months on record, sales would be between 3.45 per 100 people and 2.10 per 100.
Falling below 2.0 was very rare -- it only happened in 30 of the 540 months between January 1963 and January 2008. It has been below that level in the 35 months since then. Similarly, there is no instance of sales exceeding 4 per 100 prior to June 2003, but it happened 24 times in the 30 months between then and December 2005 (inclusive).
There was no particular demographic reason for sales to spike in the middle part of the last decade. The big bulge in the late 1970’s happened to coincide with the Baby Boomers moving into the prime age of buying a first house, their late 20’s. New houses had to be built and sold to accommodate the twenty-somethings moving into a place of their own. Even if they themselves bought an existing house, the people they bought from would need a new place. Eventually that shows up in new construction.
In addition to demographics, the other big historical factor in determining the level of new home sales has been the mortgage rate. The second graph shows the level of new home sales versus the rate on a 30 mortgage (I had to string two data series together to get rates for the whole period, but they have a long overlap and seem to track each other very closely.
Prior to the great housing collapse of the past few years, almost all of the previous instances of sales falling below 2 per 100 were due to sharp spikes in mortgage rates. That happened most dramatically when mortgage rates were pushed to 18% in the effort to break the back of inflation.
This time around, mortgage rates were clearly not the problem. They did not spike very much prior to the collapse in home sales, and record low rates have not done anything to help them rebound. Rather, the problem is that so many new homes were built and sold during the bubble, that several years' worth of demand were pulled forward.
The population of the country continues to grow, and eventually the overhang will get worked off. In the past, the ratio of new homes sold to population has shown a very strong tendency to return to the long-term average. However, the level can be above or below that level (2.77) for several years at a time.
Just returning to the long-term average level would lead to more than a tripling of new home sales. Given that each new home built and sold generates an enormous amount of economic activity, that reversion to the mean holds the seeds of a very big economic boom in the future.
As construction workers go back to work, they will have more money to spend, and as they do, it will stimulate employment in a whole array of other industries. Right now, with so many of them out of work for extended periods of time, it is a pretty good bet that they are not going out to eat much at anywhere other than McDonald's (MCD), and there not all that often.
As they start working again, they might splurge more often by going out to eat at Red Lobster or the Olive Garden (both owned by Darden, DRI). That will mean more jobs for cooks and waiters. They, then, will have more money to spend at Wal-Mart (WMT), which in turn will mean more jobs for greeters and cashiers.
New homes also consume very large amounts of building products, leading to more revenues and employment in the lumber, sheetrock and roofing industries. As more people are employed, the rate of household formation will increase. In other words, grown kids will move out of Mom’s basement and into a place of their own. That will, in turn, drive up demand for more housing. A self-reinforcing positive cycle will be under way.
Upturn a Ways Off
An upturn in housing will come, but it is not coming very soon. The drop in housing values has left almost one in four homeowners with mortgages with home values that are less than the amount of the mortgage. The farther underwater a homeowner is, the more likely the home is to go into foreclosure. For many underwater homeowners, walking away and not paying the mortgage is by far the most rational economic decision they can make.
The continuing flood of foreclosed properties is going to be tough competition for the home builders like D.R. Horton (DHI). According to a recent report by First American Core Logic, 11 million homes are now underwater, or 23% of all homes with mortgages on them. In addition, another 2.4 million have less than 5% positive equity (which given realtors fees and other closing costs would effectively put them underwater if they tried to sell today). Together, the underwater and those with their heads just above the waves make up 28% of all houses with mortgages (about 30% of all homes are owned free and clear).
As the third graph below shows, there is significant regional variation in the “home flooding.” Ironically, the worst of these floods are in the desert. In Nevada, 68% of all homes are already underwater, while in Arizona half of all houses are underwater. (Why they are trying so hard to lower their population with draconian anti-immigration legislation is a bit of a mystery, in this context. It will simply mean fewer people there and thus lower demand for housing and thus lower home values.)
With the current supply of existing houses for sale at a record high relative to the sales pace of existing homes at 12.5 months, it seems abundantly clear that the direction of existing home prices is down over the next year or so. Since houses are much more affordable now than they were a few years ago, we are not going to see another 30% decline, though a decline of 10% is very possible. As that happens, all the people in the red portion of the bars will move into the blue part of the bars, and new people will find themselves just above the waves.
When the new housing cycle takes hold, the economy is likely to boom. Unfortunately, that is not going to happen anytime soon.
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.
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