New Home Sales Slump

When it comes to the world of sticks and bricks -- building new homes to house America's families -- there has been a lot of change in the last year.

When the real estate market was red-hot, builders were breaking ground on new developments at a rapid clip to keep up with buyer interest.

But today, the market has turned. More Americans than ever already own a home and the recent mess in the subprime mortgage market means people who have traditionally rented won't be able to find inexpensive financing if they want to buy.

Those two factors have pushed sales of new homes into a nose dive. The government report which measures sales of new homes has seen a 19 percent drop in sales in the first two months of 2007.

"We know [the new homes market] is headed in the wrong direction and we're not exactly sure how it's all gonna pan out," said David Seiders, chief economist of the National Association of Home Builders. He says the association is working on a downward revision to its forecast for 2007, which had been pointing to a slight recovery by year's end.

Builders have backed off building new homes as the market has cooled. Spending on residential construction has dropped by 13 percent during the past year.

But even with the slowdown in new construction, the market is facing a unique situation: There are more new homes for sale today than there have been for 16 years.

At the current sales pace, the nation has a full 8.1 months worth of homes for sale. Analysts say that level of "oversupply" is going to make it tough for builders to get prices headed higher.

Said Seiders, "If the sales numbers refuse to stabilize soon and show improvement, that then infects everything again from there."

In most situations when there is too much supply of something in the economy, prices start to drop off, stimulating a rush of buyers into the market. But the new home acts a bit differently according to analysts.

Builders put hundreds of thousands of dollars worth of labor and materials into each new home that they have to get back. And if they cut the price of a house, it effectively reduces the market value of all the other homes they're trying to sell.

So instead of cutting the sticker price for a new house, builders are using add-on incentives to move unsold homes off their books.

Buyers around the country are getting upgraded kitchens, $10,000 home improvement gift cards and special financing deals as thank-you gifts for closing on a new home. That allows the builders to keep their homes values at a certain level and gives buyers a reason to feel good about buying in a market that's slipping downward.

The latest reports back up that trend. The median price of a new home purchased in February was $250,000, about 0.3 percent lower than the median price a year ago.

The change in the new home market has not gone unnoticed on Wall Street, where shares of the nation's largest builders are traded. The iShares Dow Jones U.S. Home Construction exchange, which tracks the value of companies of the big builders, has dropped more than 26 percent in the past 10 months.

Even with the significant fall in the new home market in the past two months, most analysts have so far stuck to their forecasts of a slight recovery in the overall market during 2007.

The overall market -- where sales of existing homes make up more than 88 percent of the total transactions -- has seen a slight rebound in the past two months, with sales up 3 percent from the December low point.

Sellers of preowned homes are more likely to cut the price of their house to move it quickly and have been doing just that. Prices are down in the existing home market, but the sales pace has been moving up during the past few months.

"Real estate is gonna get very cheap because you're gonna have a glut of it for sale with very few qualified buyers," said Peter Schiff, president of Euro Pacific Capital and author of "Crash Proof: How to Profit From the Coming Economic Collapse." "In order to clear that market, prices are going to have to get to fire sale levels."

The real key to a turnaround in the market, according to experts, is a speedy shakeout in the shaky mortgage market and a strong spring selling season. If both those things don't happen, there might be more downside to come.