Economist's Commentary: February 28, 2008

New Home Inventories Slide

By Ken Fears, Manager, Regional Economics

The latest report on new home sales, released Tuesday, brought news of further declines in sales. However, little mention was made of an important development in this sector; inventories are on their way down. Compared to January 2007, inventories decreased 10.2%, reaching their lowest point since August 2005. All regions shared in this decline, with the Northeast faring the best with a 12-month decline of 18.2%. This trend finally extended to the West, down 5.7% from a year earlier, where inventories are bloated and the potential for an increase in foreclosures is the greatest.

This drop in inventories is important for two reasons. First, the decline in new home inventories means that the bulge in inventories, which resulted from builders dumping their wares on the market from 2005 through 2007, is now under control. Second, declining inventory levels mean that the drastic price cutting that some builders and investors have undertaken is working.

Does this trend mean more competition for the existing home market from new homes? Not necessarily. Most new homes are built where land is cheaper by comparison, which is normally on the periphery of metro areas. As homes in many metro areas are re-priced in this buyers’ market, there will be more focus on the fundamentals that go into a home’s price…like proximity to shopping, public transportation, good schools, shopping and other factors. In some metros, prices became unlinked from fundamentals during the boom, but they will be re-linked during this transition period. Demand is also likely to be highest closer to city centers, where the existing market dominates. So, new homes are not perfect substitutes for existing homes.

The declining inventory of new homes does not mean that the housing market is free of potential trouble spots. Foreclosures will continue and some sellers will likely need to make more concessions in order to meet buyers’ demands. But, affordability and financing are improving and any increase in demand will further reduce supplies, enabling the market to better cope with additional foreclosures.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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