Which is Better, More Sales or Less Cancellations?
If you’re a home builder, what’s going to feel like better news? (And, oh boy, what just a little good news could do going into a weekend!)
You get to choose one or the other of the two options below:
- Higher (Commerce Department) unit sales, accompanied by higher cancellation rates?
- Or fewer orders with less cancellations? (With apologies to the grammar police).
Analysts preoccupy themselves with monthly Census and Commerce Department data. Said analysts don’t run a business in the trenches that depends on turning inventory or dies.
The Census and Commerce Departments, and most of home building’s analysts, watch orders for new homes as if they were in a vacuum. They count them one time when there’s an earnest money deposit on a home, and irrespective of whether they actually flow through to the closing table and get a deal, they stay counted.
That’s not how reality works for the builders.
They report their orders as a sale, but they dont get to book the full price as a sale until they deliver the deed over to the new owner after settlement. So Commerce may already have counted a home as a sale, but a builder can’t until the Fat Lady Sings. A builder may have to sell the same house not once, not twice, but given today’s tricky credit and appraisal environment, as many as three times to get to the tail lights on the transaction.
Which makes cancellation rates significant. Higher cancellation rates mean more orders but less done deals. This rubs two ways when it comes to a fits-and-starts housing market stabilization.
A lower total on the earnest money deposits can handily be offset–on a balance sheet–by a greatly reduced number of failed or derailed deals.
Here’s a comment from Raymond James Associates housing analyst Buck Horne, on KB Home’s 2nd quarter earnings performance:
Notably, KB Home’s cancellation rate improved to 20% in the first (should say “second”) quarter from, 28% in F1Q09 and 27% in the same period a year ago.
So, KB’s total orders for 2nd quarter fell year-on-year by 31%, but the company’s cancellation rate for the reporting period improved from 27% in 2Q 2008 to 20% in 2009.
Whether or not this data is read as downbeat or green shoots by analysts or the broader economy virtually doesn’t matter to executives who live, eat, sleep, and breathe home building.
What matters to them is that they’re doing what they need to do to make a living.
Here’s Buck Horne’s hybrid lift from the transcript from KB Home CEO Jeff Mezger’s market conditions sum-up:
CEO Jeffrey Mezger highlighted that the company is “beginning to see signs that some negative housing market trends may be moderating at both the local and national levels.” Furthermore, from management’s perspective, while it is premature to declare housing has reached the end of its severe recession, the conflicting signals it has seen could suggest the industry is “approaching a point of relative stability.”
Likewise, while not trying to betray an overly optimistic outlook, Lennar CEO Stuart Miller sprinkled positive statements among his cautious ones in talking about Lennar 2Q’s performance.
“Abject pessimism (from consumers) has given way to a sense that opportunities are available to those who qualify,” he said. “While there continue to be significant headwinds … there are some significant positive influences out there that are beginning to shape a more positive future.”
These two bellwether company CEOs know better than not to recognize another leg down isn’t entirely impossible. But they’re talking about substantive if nuanced signs of improvement.
Higher (Commerce Department) orders mean prospective buyers might be being spurred off the sidelines, but some fair number of them might not have the means to complete a home purchase.
Lower can rates mean motivated buyers and gettable credit.
When home builders can sell both the already-counted orders that fell through, and push new orders through to closing at a higher rate, they’re coming out ahead.
This is why new home inventory is headed with conviction in the right direction. Have a look at Calculated Risk’s chart and interpretation.
Click to access Calculated Risk post
There were 10.2 months of supply in May – significantly below the all time record of 12.4 months of supply set in January.
The seasonally adjusted estimate of new houses for sale at the end of May was 292,000. This represents a supply of 10.2 months at the current sales rate.
The final graph shows new home inventory.
Note that new home inventory does not include many condos (especially high rise condos), and areas with significant condo construction will have much higher inventory levels.
It appears the months-of-supply for inventory has peaked, and there is some chance that sales of new homes has bottomed for this cycle – but we won’t know for many months.
Getting inventory sold, and getting the inventory level to where it is the least cumbersome and the most flexible is the business of the home builders right now. The chasm is something they can look across if they can do this.
So which is it, higher orders per the Commerce Department or lower can rates?
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