High prices hurting new home sales
High home prices is hurting new home sales, which may slow homebuilding employment growth and perpetuate economic weakness.
In June I reported new and resale home sales slumped in the prime selling season this year. In July I reported the June new home sales numbers plummeted from June’s poor showing. Part of the reason for weak sales is ongoing weakness in the economy, and part of the reason is that new home prices are just too high.
Potential homebuyers can’t afford higher home prices because wages aren’t keeping up with price increases. If prices go up faster than wages, and if interest rates don’t fall enough to fill the affordability gap, marginal buyers get priced out and sales volume necessarily suffers.
It didn’t used to be this way. In the past, lenders would have responded with affordability products to sustain sales volumes, but the new mortgage regulations changed how real estate markets work. It’s hoped these new mortgage regulations will prevent future housing bubbles, and so far they appear to be working, but the success of these new regulations is an unanticipated change in housing market behavior: high prices are hurting sales volume.
Housing economists still don’t fully grasp the impact the new mortgage regulations have on the market. Most economists still cling to their fanciful ides of “escape velocity” and a virtuous circle of rising prices and increased buyer motivation to capture the gains from rising prices. In other words, economists coined a comfortable euphemism, escape velocity, for foolish kool aid intoxication.
Kool aid is eternal, so the motivation exists, but the key enablers (lenders) of this foolish buyer behavior can’t play their usual games because the new mortgage regulations curtailed affordability products. Without escape velocity from affordability products, previous economic theories about housing fail — miserably.
We are approaching a frozen market with most of the available inventory suspended in the clouds at prices today’s buyers can barely afford. Further, with a likely rise in mortgage rates forthcoming, the problem will likely get worse, and sales volumes may be weak for several more years. Even the homebuilders admit this now.
Toll Brothers Inc .’s shortfall in new orders for its fiscal third quarter underscores a challenge now facing the U.S. home-building industry: Aggressive price increases in the past two years have hobbled demand at a time when builders finally are ramping up supply.
Toll, a luxury builder based in Horsham, Pa., reported Wednesday morning that new orders for the quarter ended July 31 amounted to 1,324 homes.
That’s a 6% decline from Toll’s year-ago figure when analysts were expecting a gain of about 10%.
Seriously, what reason did anyone have to believe new home sales were going to be 10% higher? I confidently predicted sales volumes would be lower, and it seemed fairly obvious if you looked objectively at the conditions. I am constantly amazed that people make large investment decisions based on foolish optimism.
Toll executives noted a “lessening of pricing power,” which has been a trend of late for both new and existing homes as buyers finally have started balking at paying continually rising prices.
To me this is the most encouraging sign of a real change in the market. Rising house prices didn’t rekindle kool aid intoxication like I feared it might. Perhaps enough buyers learned the lessons of the housing bubble that it may not repeat — at least for another generation or two.
To wit, the average price of Toll’s homes contracted for sale posted year-over-year gains of 7.5% to 21.4% in recent quarters. But its average for its fiscal second quarter of $717,000 was up only 1.4% from a year earlier.
Even though momentum is waning, prices still are lofty. Toll’s average selling price is nearly 19% greater now than it was two years ago. Meanwhile, the gap between the median price of new homes and that of existing homes has widened in recent years, likely pushing some buyers this year to opt for less-expensive resales.
Actually, the widening gap between the median resale and the median new home price is largely caused by homebuilders shunning the entry level and first move-up markets. The best performing markets over the last few years has been the mid- to high- end because these are the buyers with good credit scores and enough equity to close the deal. The middle class was wiped out by the housing crash, and with high levels of student loan, auto, and credit card debt, the first-time homebuyer market is still dead.
John S. Tobey, 8/26/2014
In spite of continued improvements in economic activity and growth, homebuilding has stagnated. First, those favorable new homes sales expectations, seemingly confirmed by the Census Bureau’s positive May sales release, disintegrated with a mediocre June report, exacerbated by a historically huge downward revision of the May numbers. Now, with the mediocre July results just in, 2014’s new home sales trend is confirmed: stagnation.
With July being the tail end of the mid-year, summer selling season, homebuilder stocks can be expected to tread water. To recover lost ground, investors need to regain an optimistic, growth outlook. Unfortunately, with stagnation, that means seeing a rationale for a positive trend change when it counts most – the 2015 summer selling season.
So homebuilders have already given up on 2014, and they’re pinning their hopes on a resurgence more than six months from now. Hmmm… that doesn’t sound very encouraging.
The bottom lineThe latest new home sales report confirms that growth has leveled off, contrary to earlier expectations. … The question is, does this stagnating sales pattern indicate a slowing down of consumer activity? Or will it be limited to new homes, only? The answer will affect the balancing act between disappointing reality and hopeful growth forecasts.
The balancing act is easy to overcome; economists need to stop issuing hopeful growth forecasts and instead focus on reality — not that I’m holding my breath for any change in the foolish behavior of economists. Redfin recently hired an economist to make bold predictions; she’s predicting a surge in sales this fall. It could happen, right?
I’ll say it again because it warrants repeating: home sales and home prices will improve when the fundamentals of job and wage growth improve. Period. The rest is just noise. Eventually, the bullish and optimistic predictions of economists will come true, not because they were right, but because their poorly reasoned predictions happen to coincide with an improving economy. Even a blind squirrel finds a nut once in a while.