New Home Sales and Cancellations
No Clear Pickup in Cancellations Rates for Public Builders
New home sales, as reported by the Census Bureau, are reported when the contract is signed, whereas existing home sales, as reported by the National Association of Realtors®, are reported when the transaction closes.
This means that any change in the housing market usually shows up in the new home sales report earlier than in the existing home sales report.
For example, new home sales in April were reported at a 591 thousand on a seasonally adjusted annual rate basis (SAAR). This was off 22% from the Q4 rate. New home sales for May will be reported Friday, June 23rd (tomorrow).
However, existing home sales in May were only off 13% from the Q4 rate. Closed sales in May were mostly for contracts signed in March and April when mortgage rates were significantly lower than today.
However, with the sharp increase in mortgage rates, we might see more cancellations for the homebuilders, and cancellations can 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. 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. The only builder that reported a sharp increase recently was KB Home comparing the three months ended May 31, 2022, with the three months ended May 31, 2021.
“The cancellation rate as a percentage of gross orders was 17%, compared to 9%.”
However, as KB Home noted on their conference call yesterday, a large portion of the increase in cancellations were on “unstarted homes”.
Currently cancellation rates are below normal for the home builders. As an example, Toll Brothers recently announced 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%.
The same is true for other builders. Another example is Hovnanian: they reported a cancellation rate of 17%, down from 40% during the bust. Hovanian averaged a 23% cancellation rate in 2004 and 2005 (cancellation rates are builder specific because of their down payment 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.
A few key points are:
The new home sales report doesn’t include cancellations.
Cancellations are currently low but will probably increase.
Tracking cancellations quarterly might provide some hints about the impact of higher rates.
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