Home Sales Data Debated

Home Sales Data Debated
By Nicholas Yulico

TheStreet.com Staff Reporter
3/26/2007 1:33 PM EDT

The Commerce Department reported much-worse-than-expected new-home sales data for February, with sales dropping 3.9% from January and inventories hitting fresh highs.

The news, however, left some analysts debating the true level of demand in the housing market.

New-home sales came in at a seasonally adjusted annual rate of 848,000 units in the month, down from the revised rate of 882,000 in January, the Commerce Department said Monday.

Economists expected a rate of 995,000 home sales in February. The sales pace was down 18.3% from the year-ago level of 1.038 million.

“The new-home market is clearly weak,” says Phillip Neuhart, an economic analyst with Wachovia. “Inventories still remain a real risk for this market, and it looks like they will remain a risk for some time.”

Inventories rose 1.5% to 546,000 homes for sale at the end of February. While the total inventory is down from the peak of 573,000 units in July, the latest level represents 8.1 months of supply at the current sales rate. That marks the highest level since the early 1990s, the last major U.S. housing downturn.

High amounts of inventory on the market remains bad news for homebuilders, and shares of builder stocks fell on the news.

Hovnanian (HOV) recently was down 1.4% to $27, and Pulte (PHM) slid 1.8% to $27.07. Lennar (LEN) , which reports quarterly earnings Tuesday, fell 1.9% to $44.72.

The news comes after seemingly positive housing data last week. The National Association of Realtors reported Friday that sales of existing homes climbed nearly 4% in February, beating economists’ estimates.

However, while existing-home sales make up a much bigger part of the overall sales market than new homes do, the existing-homes sales data is a weaker indicator since it is based on closings, which can lag contracts by two months.

Still, the large drop in new sales has some industry observers scratching their heads in confusion. The number could be affected by the way the Census Bureau collects data for the sales.

The government tracks the sale of a new home, but once a contract is entered, the deal is considered final. That number isn’t changed if the contract is canceled, nor does it change if the contract is canceled and then resold later on.

That means if conditions are worsening in the marketplace and cancellations are high, new-home sales would be temporarily overestimated. When conditions improve and canceled sales materialize as actual sales, the data is underestimating true demand because the sale of the previously canceled contract isn’t counted.

Bank of America analyst Daniel Oppenheim believes the February new-home sales data likely underestimated the true level of demand, because sales of previously canceled homes are picking up. The actual sales pace was likely 900,000 to 950,000 units, compared with the reported level of 848,000 units, he wrote in a research note.

Some have argued that the new-home sales market will improve once people stop canceling contracts signed in previous months.

Last week, homebuilder KB Home (KBH) said its cancellation rate improved in the first quarter to 31% percent from the prior quarter’s 48% level.

Buyers have been canceling contracts because they see prices falling. In some cases, they’re canceling because they’re losing the ability to easily secure a loan now that mortgage underwriting is tightening.

In recent months, early payment defaults have been rising among subprime borrowers and Alt-A borrowers, which is resulting in stricter lending standards for new mortgages.

John Tomlinson, an analyst with Majestic Research, says cancellation rates have been coming down but that demand remains poor.

“This report continues to show some of the concerns we had last month, that overall gross orders are weakening,” he says. “It’s not an issue of cancellation rates so much but just that overall demand remains weak in the homebuilding sector.”

Tomlinson adds that the tightening lending standards in the subprime and Alt-A markets may be affecting sales, but it’s not yet clear to what extent.