Tuesday’s report on new home sales came in as a miss of estimates and prior revisions were all negative. This data line confirms what we all know to be the case: The housing market, at least as it relates to construction, is in a recession.
What I have always tried to do with my economic work is to connect the dots or show a pathway to why something could happen. Since the summer of 2020, I have genuinely believed the housing market could change once the 10-year yield broke over 1.94%. However, for the new home sales sector, it would put their business model at risk.
We talked about this in March, and even last year, when I wrote about the problem with the housing construction boom premise. “I don’t expect a boom in housing construction. Builders learned their lesson in the mid-2000s and understand that it is not in their best interst to create more residential real estate beyond the standard demand curve. They also learned their lesson quickly in 2018 as mortgage rates at 5% were too high for construction growth.”
Mortgage rates have risen, and the builders have many homes under construction, so they’re going to stall things until they know they can sell their homes. This is why I raised the fifth recession red flag in June. In reality, everything looks normal as long as you know that the builders don’t build homes for society; they build homes to make money.
I addressed this last summer in an article titled: Why we can’t build our way out of a hot housing market: “During the previous economic expansion from 2008 to 2019, the housing market was subject to the constant refrain of build more homes. Building more homes, it was said, would solve all sorts of social problems, from making homeownership more affordable to ending homelessness.
“Today we are perhaps less prone to believing that a glut of new homes is the panacea society is waiting for, but the siren call to build more homes continues to be broadcast by a host of housing pundits and social do-gooders. The problem with this scenario is that social do-gooders don’t build homes; builders build houses, and they build homes for money, not to cure societal ills.”
The previous economic expansion (2008-2019) had the weakest new home sales recovery; thus, we had the weakest housing construction cycle ever. That makes sense to me; builders missed sales estimates in 2013, 2014, and 2015. Then in 2018, they had a supply spike as mortgage rates reached 5%. In response, they stalled construction for 30 months. Today, rates are even higher.
It is what it is: the housing dilemma we live with in America. If the builders need sub 4% mortgage rates to build and existing home prices are up near 20%, as Tuesday’s S&P CoreLogic Case-Shiller Home Price Indices report showed, it’s hard to see how we ever get out of this mess.
New home sales
From Census: Sales of new single‐family houses in June 2022 were at a seasonally adjusted annual rate of 590,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 8.1 percent (±15.0 percent)below the revised May rate of 642,000 and is 17.4 percent (±11.6 percent) below the June 2021 estimate of 714,000
Today, new home sales are back to 2018 levels. The peak of the housing bubble was roughly 1.4 million in sales. At today’s level of 590,000 homes, the builders are in a different spot to deal with their inventory issues because they haven’t had a credit sales boom as we saw from 2002-2005. We are easily below the 2000 recession levels and back to 1996 levels in demand. Builders will manage their construction homes to ensure they don’t have too much product. Also, they’re hoping for lower mortgage rates, which helped them out in 2019.
Census: The median sales price of new houses sold in June 2022 was $402,400. The average sales price was $456,800.
There’s a savagely unhealthy housing market theme here, and my concern is home prices overheating, which can impact the housing market more than if price growth were stable. The hot home price party started in 2020, which wasn’t good. The builders had pricing power and used it well for profit margins. The consumer had to pay the price. This is how supply and demand works; the one thing that can change pricing power is higher rates.
From Census: The seasonally‐adjusted estimate of new houses for sale at the end of June was 457,000. This represents a supply of 9.3 months at the current sales rate.
My rule of thumb for anticipating builder behavior is based on the three-month average of supply:
- When supply is 4.3 months and below, this is an excellent market for the builders.
- When supply is 4.4 to 6.4 months, this is an OK market for the builders. They will build as long as new home sales are growing.
- The builders will pull back on construction when the supply is 6.5 months and above.
As we can see below, the monthly supply has taken off once again. The builder’s business model is at risk, of course.
However, we must be mindful of one reality that is different from the past: Only 0.83 months of supply is finished housing product.
- 6.22 months of supply is under construction
- 2.24 months of supply hasn’t even been started yet
We should expect that builders won’t even bring a shovel to the dirt of the homes they haven’t started on yet — and they will slow the process down to ensure the homes under construction will be sold. In the past, lower mortgage rates have helped this process out for them, so they know what they’re doing here. As we can see, like everything with housing, nothing in 2022 looks like 2008.
This is the builder’s biggest competition. They have taken advantage of the low inventory story in 2020 and 2021.
NAR: Total Inventory Data
2007 Peak Roughly 4,000,0000
I am not a housing construction boom person; this industry has limits. The new home sales sector and housing starts will grind things out until mortgage rates go lower and they can sell more product and feel comfortable building homes again. Until that time frame, it’s nothing but a savagely unhealthy housing market.