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Tomorrow (Tuesday), the Census Bureau will report new home sales for August. The consensus is for 500 thousand on a Seasonally Adjusted Annual rates (SAAR) basis, down from 511 thousand in July.
It is important to note that with the recent sharp increase in mortgage rates, homebuilders are seeing significantly more cancellations. Tracey Ryniec, Equity Strategist at @ZacksResearch noted last week that KB Home saw a huge increase in cancellations:
Other builders are seeing sharp increases too. When looking at new home sales, we are interested in net sales for each month, however 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 Census Bureau does not make adjustments to the new home sales figures to account for cancellations of sales contracts.
The Survey of Construction (SOC) is the survey used to collect all data on housing starts, completions, and sales. This survey usually begins by sampling a building permit authorization, which is then tracked to find out when the housing unit starts, completes, and sells. When the owner or builder of a housing unit authorized by a permit is interviewed, one of the questions asked is whether the house is being built for sale. If it is, we then ask if the house has been sold (contract signed or earnest money exchanged). If the respondent reports that the unit has been sold, the survey does not follow up in subsequent months to find out if it is still sold or if the sale was cancelled. The house is removed from the "for sale" inventory and counted as sold for that month. If the house it is not yet started or under construction, it will be followed up until completion and then it will be dropped from the survey.
Since we discontinue asking about the sale of the house after we collect a sale date, we never know if the sales contract is cancelled or if the house is ever resold. Therefore, the eventual purchase by a subsequent buyer is not counted in the survey; the same housing unit cannot be sold twice.
As a result of our methodology, if conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated. When conditions improve and these cancelled sales materialize as actual sales, our sales would then be underestimated since we did not allow the cases with cancelled sales to re-enter the survey. In the long run, cancellations do not cause the survey to overestimate or underestimate sales.
emphasis added
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.
The bottom line is - with rapidly rising cancellations - the Census Bureau will overestimate sales tomorrow (and underestimate new home inventory).