Economist's Commentary: May 27, 2008

Falling New Home Inventory

By George Ratiu, Research Economist

New home sales in April rose 3.3 percent, while inventory fell 2.4 percent according to today's data. Inventory in terms of months’ supply continues to remain high. However, actual number of new homes on the market for sale has been trending down. Let's examine the falling inventory and rising months’ supply more closely.

According to the Census Bureau’s latest report on new residential sales, the months’ supply of new home inventory is at 10.6 months, after reaching a record level of 11.1 months during March 2008. For the first quarter of 2008, the average month’s supply was 10.3 months. By comparison, over the past five years, the months’ supply of new homes was 5.5 months, about half the current rate.

Despite the high months’ supply figures, new home inventory has been consistently sliding for more than a year. Since hitting a high of 573,000 homes in July 2006, new home inventory dropped to 456,000 during April 2008.

Meanwhile, new home sales have also been on a steady decline. In April 2008, new home sales reached a seasonally-adjusted pace of 526,000 units, 62 percent lower than the high point of July 2005.

These numbers are not surprising considering that new homes entering the market are competing with existing home inventories, and in some markets with a good number of foreclosed and short-sale properties. However, looking at the table below, illustrating annual averages for sales, inventory and months’ supply, the first quarter of 2008 shows new home sales are well below historical levels. Meanwhile, inventory is returning to a historical average.

NEW RESIDENTIAL SALES
Seasonally-adjusted AVERAGES
Year	New Home Sales	New Home Inventory	Months' supply
1992	614	270	5.4
1993	676	279	5.1
1994	671	314	5.8
1995	666	352	6.5
1996	757	348	5.6
1997	807	289	4.4
1998	892	287	3.9
1999	906	306	4.1
2000	910	312	4.2
2001	907	302	4.0
2002	979	327	4.1
2003	1091	349	3.9
2004	1196	396	4.0
2005	1279	468	4.5
2006	1057	554	6.4
2007	768	531	8.5
2008.Q1	559	475	10.2

This, of course, begs the question: what pace would new home sales have to reach in order to return months’ supply to historical equilibrium conditions? Based on a 15-year time period (1992 – 2006), the average months’ supply of new homes comes at 4.8 months. Considering that the current new home inventory of 475,000 is in line with historical trends, the pace of new home sales would have to reach 817,000 in order to bring months’ supply in line with the historical average of 4.8 months. If new home inventory were to continue declining to a level matching the 15-year average—344,000 units—the pace of new home sales would have to be at 949,000 units to maintain the same average months’ supply of 4.8 months.

April’s rise in new home sale activity is a step in the right direction, as illustrated by the 4.5 percent decline in months’ supply of new home inventory. Considering that we are entering the traditional house-buying season, we will have to wait and see if the upswing will continue.

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