A variety of indicators suggest that sales of both new and existing homes bottomed out during the fourth quarter of 2006, and the NAHB's forecast shows a gradual recovery of sales volume during 2007. But builders should realize that the standard measures of home sales tell only part of the story about housing demand. Also, standard measures of housing inventory provide an inadequate assessment of the true weight of the current and potential overhang.
GROSS VS NET SALES Data on sales of existing homes (from the National Association of Realtors) are based on closings. Thus, this series actually measures net sales, meaning contract signings less cancellations of sales contracts before closing. As such, the series relates to purchase decisions made a month or more earlier, but at least a “sale” means that a property actually has changed hands.
Official government data on sales of new single-family homes are based on contract signings rather than closings, providing a timely measure of purchase decisions in this market. However, this data system does not record cancellations of sales contracts, making estimates of net sales impossible.
The NAHB's surveys of large single-family builders show that cancellation rates have roughly doubled since late-2005, partly reflecting cancellations by investors/speculators as prospects for price appreciation gave way. Thus, the falloff in net sales has been much deeper than the reported decline in gross sales. Indeed, cancellations still were running quite high as 2006 drew to a close, and this factor is likely to remain a sizeable drag on net sales as we move into 2007.
INVENTORY OVERHANG The government's measure of the inventory of unsold new homes rose to a record level in the latter part of 2006, even though this measure excludes homes left with builders due to sales cancellations. Indeed, as cancellations surged in 2006, the reported inventory numbers fell further and further below the true number of homes for sale by builders.
Inventories (listings) of existing homes also rose to record levels in the latter part of 2006. To the extent that existing homes for sale are occupied, a run-up does not necessarily threaten the overall supply-demand balance in the housing market—since the sellers ordinarily will buy other units. But we find that an unusually large proportion of existing homes on the market now are vacant units—a legacy of the surge in buying by investors/speculators during the boom period. Vacant units in the existing for-sale housing inventory are a much more serious matter than occupied units in that inventory.
We're also facing a “phantom inventory” of uncertain dimensions, consisting of homes owned by investors who are awaiting stabilization or improvement of market conditions before listing the homes for sale. Many of these homes were bought from builders during the boom and pose a real threat to new production down the line.
BOTTOM LINE The recoil from the investor-driven housing boom of 2004—2005 is not yet complete. Cancellations are bound to take a serious toll on net sales for some time to come, and resales of units held by investors/speculators will delay fundamental improvement on the inventory front. In view of these forces, builders should carefully evaluate the true supply-demand balance in local markets and formulate 2007 production plans accordingly.
David F. Seiders, Chief Economist, NAHB Washington, D.C.
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