Are falling new home sales in December a warning for 2014?

August new home sales, as reported by the Census Bureau and the Department of Housing and Urban Development, decreased 6.9% from November

New home sales decreased to an annualized pace of 414,000—down 6.9% from November (which was revised down from an initial estimate of 464,000 to 445,000) and up 5% from a year ago. Activity picked up in the Midwest while falling everywhere else. It’s important to understand that this number is an estimate, and these numbers are often revised several times. Investors should understand that these estimates can be volatile and should not read too much into any one specific number.

Restricted supply has been the theme of the U.S. housing market over the past year

At the end of December, there were 171,000 new homes for sale, representing a five-month supply. The median time a new home has been on the market has shrunk from nine months last summer to the current figure of five months. As professional investors have become major players in the real estate market, we’re seeing bidding wars for properties in the hardest-hit markets, like Phoenix, and even strong markets, like Washington, DC. For all the fears that a flood of properties would hit the market and drive down prices, the opposite problem has happened.

Prices are beginning to rise

The median sale price for a new home was $270,200, and the average price was $311,400. These numbers aren’t based on a repeat sales methodology, so you can’t project nationwide existing home prices from these figures. On balance, the jump in prices implies that more activity is happening at the high price points. That said, the report showed that the sweet spot for new home sales has been in the $200,000-to-$299,000 range.

Homebuilder earnings were strong

Homebuilders like PulteGroup (PHM) and DR Horton (DHI) will report fourth quarter and full year earnings this week. Reports noted particular strength in the West Coast, and also in the entry-level and first-time move-up sector. KB Home (KBH) and Lennar (LEN) recently announced fourth quarter numbers that showed that the increase in interest rates and home prices is keeping the first-time homebuyer on the sidelines. That said, homebuilder sentiment is at all-time highs, and the earnings reports we have seen so far from the builders don’t suggest activity is beginning to wane. If anything, the improving economy is driving more demand. The spring selling season is just around the corner.

The Home Builder ETF (XHB) may be leveling off, but we’re still very, very early in the housing recovery. The first-time homebuyer has been absent due to tough credit conditions and a difficult labor market. As those circumstances change, a lot of pent-up demand will release, which should drive homebuilder earnings for quite some time.

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