There's A Troubling Dynamic Developing In The Market For New Homes

Connecticut, construction

Photo: flickr / MattZwilling

Years after the housing bubble burst, the market appears to have stabilised and there seems to be no shortage of signs of improvement.  Home prices are up year-over-year, homebuilder confidence is at a six-year high, and just this week housing starts crushed expectations.  Deutsche Bank economist Joe LaVorgna estimates that confidence is telling us that starts will double within six months.And the homebuilders like Lennar and PulteGroup all see signs of a recovery.  Indeed homebuilder stocks have been outpacing gold.

Both Goldman Sachs and JP Morgan have published long lists of reasons to be bullish about housing.

But when you start pairing the data together, you start to see warning signs you would’ve learned about in economics 101.  Specifically, you’ll see signs that supply is outpacing demand.

In the wake of yesterday’s huge housing starts report, Wall Street Examiner’s Lee Adler noted that starts appeared to be outpacing sales.

TD Securities economist Millan Mulraine, who remains bullish on housing, also pointed to similar warning signs in a research note today.

“The exceptionally strong surge in residential construction activity and building permits approval in September has caused us to question whether homebuilding activity is beginning to edge too far ahead of the market’s capacity to absorb the new supply,” wrote Mulraine.  “Particularly given the current weak economic outlook in the medium term.

“The key risk is that prices in this segment of the market could come under pressure in the near term unless demand for new homes pick up more meaningfully in the coming months, justifying the optimism among builders.”

Check out the spread between housing completions and new home sales:


Photo: TD Securities

From Mulraine:

…the non-annualised pace of new home completion has outpaced sales activity in this segment of the market every month this year. Up to the end of August, the accumulated gap between completion and sales this year has widened to 144K, and at the current pace so far this year, the gap appears likely to widen to around 200K. While this is not a particularly worrying level of inventory, the acceleration in the pace of starts in September, if sustained, will push the level of new homes supply well over twice the current pace of sales activity. To close this gap, new home sales will need to double from the current pace of 373K.

 Another problem for the new homes market is the attractiveness of the existing homes market:


Photo: TD Securities

From Mulraine:

The Achilles’ heel for the new homes sector continues to be the competition from the massive supply of distressed properties still to be worked off in the market. With prices for existing homes still down 33% from their peak compared to new home prices (which are now within striking distance of their pre-crisis peak), the preference for new homebuyers will continue to be for the bargains to be had from the existing homes market, until this premium falls back to historical norms.

All eyes will be on next Wednesday’s new home sales report to see if this troubling dynamic continues.


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