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New Home Cancellations increased Sharply in Q3
"Significant shift in market conditions"
First, a few quotes from some homebuilders:
"During most of the year, demand for our homes was strong. Beginning in June and continuing through today, we have seen a moderation in housing demand caused by significant increases in mortgage interest rates and general economic uncertainty.” [Donald R. Horton, Chairman of the Board, said] …The Company’s cancellation rate (cancelled sales orders divided by gross sales orders) for the fourth quarter of fiscal 2022 was 32% compared to 19% in the prior year quarter. D.R. Horton
“In response to the significant shift in market conditions in 2022, we have slowed the pace of our housing starts, have increased sales incentives, and are taking additional pricing actions in many of our communities.” Pulte Group
New Orders decreased 15%, while the average sales price of New Orders increased 3% in the third quarter of 2022 compared to the third quarter of 2021. New Orders were negatively impacted in each of our reportable segments by the significant increase in mortgage interest rates during the quarter, which resulted in a decline in affordability and in turn, led to lower absorption rates and to an increase in the cancellation rate quarter over quarter. NVR
Clearly cancellations increased in Q3, 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 (or only report as a percent of backlog).
Here is a table of selected public builders and the currently reported cancellation rate (I’m still gathering data).
Disclaimer: the cancellation rates are from SEC filings only, and while deemed to be reliable is not guaranteed.
In general, cancellation rates doubled or tripled in the most recent quarter compared to 2021.
Toll Brothers reported a cancellation rate of 13.0%, well above their historical rate of 7%. During the housing bust, Toll Brothers cancellation rates peaked close to 40%!
For D.R. Horton, the 32% cancellation rate was well above their normal rate in the 16% to 20% range. 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 Q3.
This suggests that new home sales in recent months were lower than the gross sales reported by the Census Bureau.
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