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New Home Starts? Don't Make Me Laugh!

Tuesday, October 03, 2006 | 06:47 AM

in Data Analysis | Economy | Real Estate

I continue to be astonished by the econopundit's lack of solid connection with reality. It's as if Faith-based initiatives have worked their way into economic analysis and forecasting.

The reaction to last week's New Home Sales -- a surprising headline of a 4.1% rise in August -- suggests to me that many people simply do not read beyond the headlines. That is a terrific way to insure you have an incorrect grasp of the data and details of any economic release.

This report was a perfect example: If you didn't know 3 factoids about New Home Sales, you might be tempted to believe sales are stabilizing, and that the worst is over for housing. Here's what you need to know anytime you see the New Home data:

- The data itself is reported not by a neutral observer, but by the Builders (an interested party) to the Commerce Department;
- The margin of error is typically greater than the reported number, rendering it statistically insignificant;
- Cancellations of New Home Sale contracts are omitted from both the inventory and sales data.

Let's have a look at how strong the report was:

New Home Sales only appeared to rise due to a downward revision of sales in May, June and July. But for those downward revisions, the overall trend of slowing sales has been continuing. And, once the August data is revised, it will likely show further deterioration in sales.

Why the difference between reported sales and reality? One reason may be cancellations. As Bloomberg's Caroline Baum noted, "rising cancellations aren't being captured in the aggregate statistics because of the way the survey is designed. Hence, sales are being overstated and inventories understated."

Examples:

• Lennar said its cancellation rate was running at more than 30 percent. That means about 1 in 3 i of Lennar's reported new home sales not only didn't sell, but are back in the already bloated inventory stockpile. That's on top of the 5 percent decrease in new slaes Lennar had in their quarter ending August 31.

• At D.R. Horton (the 2nd largest homebuilder in the US) "cancellation rates rose to 29 percent in the April-June quarter." They deteriorated further in July. That's about double their historic average;

• KB Home said net orders plummeted 43 percent in the three months ended August 31. That rate is inclusive of cancellations.

As you can see from 3 of the largest US homebuilders, actual new home sales -- as opposed to reported ones -- did not increase over 4%. Including cancellations, I would guess that new home sales actually dropped somewhere between 5-15%.

Consider too what has been happening in some of the formerly hottest housing regions of the country: Barron's reported that Florida, for example, saw August existing home sales drop an amazing 34%; condo sales plummeted 41%.

Given that the homebuilder's sentiment index (expectations of sales six months) fell to a 15-year low, perhaps the actual data is even worse (we just don't know).

Stabilizing? Nothing could be further from the truth.

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Sales & Inventory, New & Existing Homes (Combined)