The New Homes vs Existing Homes Markets

The housing market has been providing mixed messages lately.  Relatively good news is spouted by the media one day, followed by bad news the next.  From home prices and mortgage default rates to home sales and housing starts, housing-related data appear to move in incongruous paths.  One particular area where messages get mixed relates to the media coverage of new home sales versus existing home sales.

Month-to-month data points from this year were as follows:

The first point of divergence is that new home sales measure contract signings, not closings.  Existing home sales measure closings.  The real world economic impact from the exchange of keys to hiring moving trucks comes about from closings and not contracts.  There is no official published data on the number of closings for new home sales.  There will surely be some contract fallout.  At the initial stage of the housing market bust years, many large builders were reporting contract cancellations to the tune of 30 percent.  But one can figure that the newly built home will eventually close, isn't left vacant for an extensive time period nor gets demolished.

Second, while new home sales may not imply anything about fundamental housing demand, the news portrayal often suggests that it does.  For example, when new home sales fall the media interpretation invariably says that people are not buying homes.  Certainly this sounds reasonable, but it is wrong.  New home sales are directly influenced by how many new homes are built.  That is, new home sales are a function of supply, and not demand.  If only very few are built, then irrespective of how strong the demand may be, there will only be a few new home sales, period.  One could say that builders are not building because of lack of demand, but there have been times when builders were not building solely because of the unavailability of construction loans.  Moreover, there are times when housing demand is rising, but it is best for builders not to build because the demand first needs to clear off the excess existing home inventory sitting on the market.  The chart  below plots single-family housing starts and new home sales.  As you can see, new home sales are a function of the supply of new homes being built.  The minor difference between the two graphs is due to some owner-initiated housing starts, which never gets counted as a new sale.

Note also that the inventory of newly constructed homes for sale on the market is at a 40-year low.  Therefore, one cannot presume it is due to dire housing demand.  However, it fits into the story that new home sales are really a function of supply, which currently is due to very low levels of housing starts.

Another difference relates to price.  New home prices must reflect the cost of construction or else the homebuilders will be building at a loss, so it would be better to postpone building rather than do all the work for a financial loss.  New home prices, therefore, must capture the recent rises in commodity and construction-related costs.  Existing home prices, meanwhile, are determined by the forces of supply and demand.  Prices must adjust in order to attract buyers.  Foreclosed properties in particular must be sold at any price that gets them sold, unrelated to profit/loss or the costs of construction.  This difference has now opened up a new home price premium that is far above historical norms in relation to existing home price.

Finally, the most important difference between the new and existing home market is the relative size of the two markets.  The existing home sales market accounts for over 90 percent of all home sales in recent months.  Despite the dominance of the existing home sales market, with American buyers and sellers making exchanges primarily on existing homes, the new media would cover the existing home sales statistics at about equal level with the new home sales data.  That is fine if the reporter mentions that new home sales make up less than 10 percent of the market.  But it would be misleading to the consumer audience if a reporter simply discusses the direction new home sales are trending without a reference to market size, because consumers might unknowingly place equal listening time and equal weight to the trends in new home sales as in existing home sales.  (For economists, who are focused on GDP calculation, more focus would be placed on new home sales because construction worker wages and material purchases are more important to the computation of economic impact than that from the sales of existing homes.)