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RISMEDIA, March 27, 2007-(MarketWatch)-Sales of new homes unexpectedly dropped in February to the lowest level seen in nearly seven years, while inventories of unsold homes rose to a 16-year high, suggesting that the nation's housing market was softening heading into the vital spring buying season.

Sales of newly constructed single-family houses unexpectedly slowed again in February, falling 3.9% to a seasonally adjusted annual rate of 848,000, the lowest level since June 2000, the Commerce Department reported Monday. Sales were down 18.3% compared with February 2006.

Economists surveyed by MarketWatch had been expecting an increase in February to about 1 million units.

"Housing still has some distance to fall," wrote Phillip Neuhart, an economist for Wachovia, in a research note.

Inventories of unsold homes rose 1.5% to 546,000, representing an 8.1-month supply, the largest inventory in relation to sales since January 1991, at the tail end of a recession. The inventory is up 27% in the past 12 months.

Inventories are probably understated, however, because they don't include homes thrown back on the market due to buyer cancellations.

Record backlogs

The number of completed but unsold homes rose to a record 179,000 in February from 177,000, up 43% from a year earlier.

"There is an enormous backlog of unsold new homes that have to be worked off before builders will start building spec homes," wrote Ray Stone, chief economist for Stone & McCarthy Research, in a research note.

Also, sales in January were revised lower to show a 15.8% drop to an 882,000 annual rate, compared with the 937,000 reported previously. Reported sales for December and November were also revised lower.

The government cautions that its housing data are subject to large sampling and other statistical errors. Large revisions, as happened in January, are common. The standard error of 17.4% is so high, in fact, that the government cannot be sure in most months whether sales rose or fell.

It can take up to six months for a trend in sales to emerge. New-home sales have averaged 959,000 a month over the past six months, compared with 988,000 in the six months running through January. The six-month sales average is now down 21% from last February's 1.22 million pace, and is the lowest since July 2002.

Details of the report

The median price of a new home was $250,000, down 0.3% from February 2006.
The high inventories and weak sales are "a prescription for a material decline in prices," Stone said.

Regionally, sales rose 25% in the West after a 26% drop in January. In February, sales fell 27% in the Northeast, 20% in the Midwest and 7% in the South. Bad weather in the northern tier of the nation undoubtedly hurt sales.

Local weather conditions can play havoc with housing data in the winter months. Most observers say sales in the prime selling months of March, April and May will set the tone for this year's sales.

"It is dangerous to over interpret the February numbers given the weather, so it is probably best to wait until March and see what a more normal weather month brings," wrote Stephen Stanley, chief economist for RBS Greenwich Capital.

Residential builders have piled on incentives, including free vacations and new cars, to sell homes and reduce inventories. Such incentives are not subtracted from the sales price reported to the government.

Sales are reported when a contract is signed, not at the closing of the sale. Builders have reported a large increase in cancellations in recent months. Since cancellations are not reflected in the government data, reported sales are likely overstated.

Last Friday, the National Association of Realtors reported that sales of existing U.S. homes rose about 4% to a seasonally adjusted annual rate of 6.69 million in February, the third increase in a row. Inventories of existing homes continued to climb.

Rex Nutting is Washington bureau chief of MarketWatch.