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New Home Cancellations increased Sharply in Q2
First, a few quotes from some Q2 SEC filings:
"We believe the recent increases in interest rates during 2022 have caused buyer apprehension, affordability concerns, and an increase in cancellations.", Taylor Morrison Q2 SEC Filing
"The magnitude and speed of these recent rate increases has caused many buyers to pause and reconsider a home purchase, resulting in lower gross demand and higher cancellations during the second quarter.”, MDC Holdings Q2 SEC Filing
"New orders weakened during the second quarter of 2022 in many of our markets and we experienced a higher than normal cancellation rate during the second quarter of 2022", LGI Homes Q2 SEC Filing
Clearly cancellations increased in Q2, and cancellations impact the reporting of new homes sales. When looking at new home sales, we are interested in net sales, but the Census Bureau reports gross new sales. A simple equation would be:
Sales (net) = Sales (gross) – Cancellations + Sales of earlier cancellations.
In the long run, the cancellation terms balance out, and the Census Bureau numbers are what we want. In other words, Sales(net) = sales(gross). But in the short run, when cancellations increase, the Census Bureau overestimates sales; and when cancellations decrease, the Census Bureau underestimates sales.
Here is a discussion from the Census Bureau: How does the Census Bureau handle cancelled sales contracts?
The public builders typically report net sales and cancellation rates. Using the public data, we can estimate net vs. gross sales for the industry and adjust the Census Bureau estimates accordingly (if there is a huge change). Luckily the analysis isn’t too difficult: when cancellations rates are rising, net sales are typically below gross sales, and when the cancellation rates are falling, net sales are usually above gross sales.
Unfortunately, the homebuilders report quarterly with a lag. And some homebuilders don’t report cancellation rates in their SEC filings.
Here is a table of selected public builders and the currently reported cancellation rate (I’m still gathering data). There is some seasonality to cancellation rates.
Disclaimer: the cancellation rates are from SEC filings only, and while deemed to be reliable is not guaranteed.
Cancellation rates clearly increased in Q2. Toll Brothers quarter ended in April (before the sharp increase in mortgage rates), and they reported a cancellation rate of 3.8%, down from 4.3% the previous quarter, and well below their historical rate of 7%. During the housing bust, Toll Brothers cancellation rates peaked close to 40%.
For D.R. Horton, their normal cancellation rate is in the 16% to 20% range, so they were above the normal range in Q2. During the housing bust, Horton’s cancellation rate was close to 50% for a couple of quarters in 2007 and 2008.
A few key points are:
The new home sales report doesn’t include cancellations.
Cancellations increased sharply in Q2.
This suggests that new home sales in June were lower than the gross sales reported by the Census Bureau.
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