New Residential Homes Inventory Months of Supply – Easy Trends (thru February 2012)

Sales of new residential homes contributes to the GDP, and the level of supply can indicate something about prices.  I’m continuing a feature called “Easy Trends” – a place where I’ll analyze the recent trend for an indicator (in this one, it is new residential homes inventory) and discuss whether it is currently going up, down or neither.  You can read the basics of my methodology on the FAQ page.

Quick ‘n Easy

When there are too many new residential homes still left unsold (inventory) on the market, it usually means that prices will be dropping because supply is greater than demand.  A good way of measuring the inventory is to calculate how long it would take that inventory to sell at the current pace of sales.  The normal level of supply for new residential homes is around 6 months.  For February 2012, the number came in at 5.8 months.  This would suggest that new home prices are likely to stay about the same in the coming months.

When there are too many new residential homes still left unsold (inventory) on the market, it usually means that prices will be dropping because supply is greater than demand.  The opposite is true if there is very low inventory.  A good way of measuring whether current levels of new residential homes are too high or too low is to calculate how long it would take the current inventory to sell at the current annual pace of sales.  For example, if there are 150,000 unsold new residential homes with the most recent report saying the annual pace of sales was 225,000, here’s what the calculation would look like:

Example:
225,000 new residential homes sold per year
divide by 12 to get 18,750 new residential homes sold per month
150,000 unsold homes divided by 18,750 sold per month = 8 months supply

 Here’s a graph of the New Residential Homes Inventory Months of Supply from Calculated Risk:

New Residential Homes Inventory Months of Supply February 2012 - Calculated Risk

Courtesy: CalculatedRiskBlog.com

Trends and Projections

Below, I will discuss whether the indicator is currently in a trend, when the last confirmed trend was and what that says about projecting the next data point to be released.

Trend Analysis

Quick ‘n Easy

We currently have a confirmed downtrend (which is good) in months of supply of new residential homes on the market.  From July 2010 to February 2012, this was been dropping by about 0.17 per month.  Perhaps we’ve hit a point where this number will not drop much further.  It is now slightly below the equilibrium point, which suggests that new residential homes prices should either stay about the same or rise slightly in the coming months.

New Residential Homes Inventory Months of Supply - Trends - February 2012

Source Data: U.S. Census Bureau

NOTE: I’ve slightly modified the way I analyze trends to conform to statistical norms.  As a result, a trend that started long ago (Jul 2010) is actually still intact today!

Current Trend: Jul 2010 – Feb 2012 – During this time, there was a confirmed downtrend with a virtually 100% chance that the months of supply was decreasing by about 0.17 per month.  Although the latest two readings have been progressively higher, statistically they were still considered part of the downward trend.  If they actually represent the beginning of a change in direction, that would likely result in an off trend (too high) reading next month.

Last Confirmed Trend: My analysis began from June 2010

Projected Next Data Point

The next report is for March 2012.  Assuming the recent trend (excluding any off trend) continues, we would expect the months of supply of new residential homes for March 2012 to be about 5.2 months, which would suggest that the price of new homes would likely be rising in the coming months.  Given how difficult it should be to get too far away from the normal figure of about 6 months, this projected number is unlikely to materialize next month.  Instead, I would expect several off trend data points in a row (too high).

Easy Take

We are still sitting below the stabilization point of 6 months.  At the most recent pace of sales, it would take about 5.8 months to sell off the remaining unsold inventory of new residential homes.  That’s below the level at which prices generally stabilize.  This means that prices of new residential homes are likely to stay stable or even slightly rise.  We have to be pleased that the market has done its job of properly adjusting the level of new residential homes being built so that the inventory number stays very close to normal.  The months of supply was as high as 12 in the recession a few years ago!

Now, the important thing to remember is that this doesn’t mean the new residential homes market is in good shape overall.  It just means that prices are in better shape.  We want there to be more new homes built and sold, which would add significant amounts of dollars to the nation’s gross domestic product (GDP) – in other words, we want new residential homes to contribute to our economic wealth.  But that won’t happen until we see a broader recovery that brings more jobs and income to people, which makes them want to buy new homes, which makes builders want to go out and build more new homes.  For now, I’m satisfied to see the inventory of unsold new homes near a stable point.  The rest will take some time.

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