Home Builders Eye the Gap Between New and Existing Sales
It’s one of the things that makes home building executives lose sleep these days (or nights). It’s what no home building company executive alive ever had to contend with in all of his or her downturns past. It’s the yawning divide between existing home sales and new home sales.
Bill, the rock-star economics and housing analysis blogger formally known as Calculated Risk, calls the widening spread between resales and new sales The Distressing Gap. In fact, he traces the ratio of new to existing home sales going back to the 1960s, and finds that for most of that time, the relationship between new and existing has been pretty steady, “until recently.”
So, you can see that no matter how many cycles any active home building executive tells you he or she has been through, none has been through one whose plot line has run like this one.
SAI Consulting principal Fletcher Groves plots the ratio a slightly different way. It looks this way.
An interesting way to state the ‘distressing gap’ is the ratio of new home
sales to sales of existing houses.EOY Approx. Ratio
1994 1:7.0
1995 1:5.8
1996 1:5.3
1997 1:4.8
1998 1:5.5
1999 1:5.0
2000 1:5.9
2001 1:5.6
2002 1:5.7
2003 1:5.5
2004 1:5.2
2005 1:5.7
2006 1:5.4
2007 1:7.4
2008 1:7.9
2009 1:12.5
2010 1:13.1The ratio was in a narrow range of 1:5 to 1:6 for about 12 years, starting
in about 1995, until 2006. In 2007, the ratio widened by about 40%, from
1:5.4 to 1:7.4, and has since widened by almost 80%, from 1:7.4 to 1:13.The ratio has widened by almost 150% since 2006. If homebuilders didn’t
know it before, they know it now; they don’t just compete with other new
home builders.
We know that Calculated Risk says that sales of distressed and foreclosure homes are the cause of the gaping gap, and that’s fairly evident. His concern is that until–many, many months from now, the inventory of troubled-loan homes finally gets cleared–new homes, and their contribution to GDP via the residential investment component will be a non-starter.
We asked Fletcher about whether he sees a return to the norm in the ratio anytime soon, as we have a hunch that younger buyers hitting the market in the next two to five years will begin to bias the trend back toward new.
Here’s his reply.
I think it is fundamentally about the relationship between supply and demand. I am not sure how the demand component works, but builders exercise more control over the supply of new homes than owners exercise over the supply of existing homes. And, to a degree, the control that builders exercise over supply is actually lenders exercising control over builders.
I think that factor has resulted in the declining percentage of new home sales to total sales. But, I also spoke with David McCain at MPKA this morning, and we both concluded that supply in the absence of demand is irrelevant.
Somewhere in all of this is the issue of how much capacity remains, or will remain, in the homebuilding industry, and – here is where my interest comes in – how productively that capacity will be utilized when demand finally returns.
I think you can say, for whatever reason, the ‘normal’ ratio (or maybe the historic ratio) of new homes sales to sales of existing homes has been about 1:5, and, right now, it is at 1:13. Where does it inflect? I don’t know. CR thinks the current ratio is a reflection of the current level of distressed sales. I don’t know if I agree or disagree.
I think you can also say – unless there is some kind of socio-economic plate shift going on in homeownership – that the demographics point to a much higher long-term level of demand for new housing than the level of demand that is present now.
We agree that builders can and do control supply right now and that the only thing missing from the low supply equation is a prevailing sense of scarcity. Aligning with folks like SAI, builders can use velocity to overcome some of the price and profitability hurdles they encounter in a market where value is still on a slippery slope.
It used to be that marketing and selling skills played a role in creating need and urgency where there once was none. But that was when banks were more willing to loan money for home mortgages.
We’ll conclude that certain home builders will find ways to exploit the wide gap between existing and new home sales as their opportunity–some have already begun to do that by widening the value margin in the total cost of home ownership with energy and water efficiency new homes. This is one area where existing home sellers can not gain an advantage over new home builders.
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