If May's 4.6 percent jump in new-home sales seemed like a bright spot after public builders' dismal first quarter results, it was a fleeting one. As the second quarter numbers roll in, it's clear the industry is out of line with demand.

Although not all public builders' numbers were released at press time, housing analysts' early estimates put the group's average decline in orders growth around the 30 percent mark year-over-year.

Some builders, however, appear to be on slippier slopes than others. For example, whereas Lennar Corp. squeaks through the second quarter with a 3 percent decline in sales, WCI Communities issues a depressing second-quarter trends statement. The Bonita Springs, Fla.–based company reports that for the first two months of its second quarter, total home building orders declined almost 50 percent year-over-year. Traditional home building orders fell 52 percent while tower building plummeted 84 percent during the same period.

And the bottom is yet to come, says JMP Securities analyst Alex Barron. “I think it's in the next two quarters [that] we're going to get the worst sales, worst cancellations,” he says.

Barron is not alone in having an unhealthy prognosis for the industry. According to Credit Suisse's research team, roughly 52 percent of orders normally are captured in the first two quarters of a fiscal year. With new orders front loaded, the outlook for the back half of the fiscal year is anemic.

However, waning demand aside, inventory is the business metric that will really bite builders in their backsides.

New-home inventory reached 550,000 in May, creating a 5.5 months supply of new homes. Although that was a slight fall from March and April levels, it represents a 23.9 percent rise from a year ago. The more chilling part is that the bulk of inventory–4.5 months worth–is speculation homes. And between burgeoning cancellation rates and hard-to-rein-in, even-flow production models, new-home inventories are likely to climb further north.

Like a Honda that runs on fumes, some of the public builders are still spitting out homes at the same pace as a year ago but without the same demand to fuel it. The market seems to have careened off course too fast and too furious for them to autocorrect. During Lennar's second quarter conference call, CEO Stuart Miller sums it up: “Like other public home builders, we don't adjust like a speed boat; we adjust like a cruise ship.”

With more inventory to burn through, a vicious and competitive cycle of incentivizing is grabbing hold, putting pressure on gross margins across the board. Barron calls it a prisoners' dilemma of sorts, in that builders that are undercutting competition “are just looking out for their [immediate] best interest not realizing that their best interest is the best interest of everyone.”

And with existing-home inventory 41 percent higher in May than the previous year, builders will soon realize that they are lock-step with not only their builder competitor down the street but also the investor buyer that they sold a home to a year ago. When they do, they'll be in whole other world of hurt.

“You've got the flipper, the builder, and the other builder [competing for a sale]. So who's going to win that war? Well, right now the builder is winning. … But, at some point, the flipper's going to say, ‘I'm going to sell [the home I bought a year ago] at a loss [because it's taking too long to sell].' We haven't seen that happen, but it's coming. And then the builders will report even worse numbers,” Barron explains.

Home Builder Quarterly New-Order Results and Expectations* SOURCE: COMPANY DATA AND JMP SECURITIES ESTIMATES