New Home Sales and Cancellations
At first glance, we might think that new home sales, as reported by the Census Bureau, would be impacted by rising mortgage rates sooner than existing home sales. This is because new home sales are reported when the contract is signed, but existing home sales are reported when the transaction closes.
However, with the sharp increase in mortgage rates, we might see more cancellations for the homebuilders, and cancellations confuse the timing issue.
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.
Currently cancellation rates are below normal for the home builders. Here is a table of selected public builders and the currently reported cancellation rate (I’m still gathering data).
As an example, Toll Brothers just announced a cancellation rate of 4.3%, up from 3.3%, but well below their historical rate of 7%. During the housing bust, Toll Brothers cancellation rates peaked close to 40%.
The same is true for other builders. Another example is Hovnanian: they reported a cancellation rate of 14%, down from 40% during the bust. Hovanian averaged a 23% cancellation rate in 2004 and 2005 (cancellation rates are builder specific because of their downpayment and pre-qualification requirements).
For D.R. Horton, their normal cancellation rate is 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.
The key points are:
The new home sales report doesn’t include cancellations.
Cancellations are currently low but will probably increase.
New home sales (from the Census Bureau) might not be a leading indicator of the impact of higher mortgage rates due to cancellations.
Tracking cancellations quarterly might provide some hints about the impact of higher rates.