A YEAR AGO, A BUYER CANCELING A CONTRACT on a new home wasn't all bad news. It often meant that the builder could capitalize on rapid price appreciation by reselling the home at a significant increase.

Today, increasing cancellation rates are a sign of an industry in transition. Investors largely have fled the market, canceling contracts on homes they'd have trouble flipping for profit. At the same time, other investors are selling homes they just bought, leading to sharp increases in for-sale inventory and making it difficult for new-home buyers to sell their existing homes, another factor driving cancellation rates higher.

It's a problem from the top of the industry on down. During Centex Corp.'s fourth-quarter conference call with analysts in April (the company's fiscal year ends March 31), it announced a cancellation rate of 30 percent, up from 23 percent a year earlier. Chairman and CEO Tim Eller told listeners that the company's cancellations began increasing in the late summer last year and continued climbing through February. The rate seemed to have reached a plateau during March, but Eller said that it was too soon to tell if the trend had changed.

Other builders expect their cancellations to begin drifting downward. “Most of the investors, from what we can tell, have worked their way out of the market,” Don Tomnitz, vice chairman, president, and CEO of D.R. Horton, told analysts during his company's second-quarter conference call. Horton's cancellation rate hit the low 20s during its second quarter; Tomnitz expects it to get back to normal—17.9 percent, historically—during the third and fourth quarters.

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TICKING UP: Mortgage rates continued to move higher in May, as the Federal Reserve raised the Federal Funds rate to 5% and did not indicate whether that would be the last hike.
SOURCE: Freddie Mac TICKING UP: Mortgage rates continued to move higher in May, as the Federal Reserve raised the Federal Funds rate to 5% and did not indicate whether that would be the last hike.
NOT BUYING: Consumer sentiment dipped again in April. Thirteen percent of consumers said that high interest rates make it a bad time to buy a home.
NOT BUYING: Consumer sentiment dipped again in April. Thirteen percent of consumers said that high interest rates make it a bad time to buy a home.
BOUNCE BACK: The Midwest showed signs of life in April, posting a 16.3% gain in starts over March and a 4.2% increase against April 2005. The South and West regions struggled in April.
Photo: Credit BOUNCE BACK: The Midwest showed signs of life in April, posting a 16.3% gain in starts over March and a 4.2% increase against April 2005. The South and West regions struggled in April.
REVISED UPWARD: The U.S. Census Bureau and the National Association of Realtors revised recent home price data up, but prices for existing and new homes lagged in March.
REVISED UPWARD: The U.S. Census Bureau and the National Association of Realtors revised recent home price data up, but prices for existing and new homes lagged in March.
GOOD NEWS, BAD NEWS: Headlines shouted about March sales rebounding from February, but year over year, sales were down 7.2%, and for-sale inventory was up 25.4%.
GOOD NEWS, BAD NEWS: Headlines shouted about March sales rebounding from February, but year over year, sales were down 7.2%, and for-sale inventory was up 25.4%.
HISTORY LESSON: The slowing market showed up in April's permit data, as builders pulled permits at a rate not seen for more than two years.
HISTORY LESSON: The slowing market showed up in April's permit data, as builders pulled permits at a rate not seen for more than two years.
FALLING FURTHER: Builder confidence declined sharply in May, with more respondents viewing sales conditions as poor. Sentiment fell across all four geographic regions.
FALLING FURTHER: Builder confidence declined sharply in May, with more respondents viewing sales conditions as poor. Sentiment fell across all four geographic regions.
SETTLE IN: The U.S.-Canadian lumber dispute resolution says that taxes will be levied on Canadian shipments if the composite price for framing lumber drops to $355 or below.
SETTLE IN: The U.S.-Canadian lumber dispute resolution says that taxes will be levied on Canadian shipments if the composite price for framing lumber drops to $355 or below.

If mortgage rates continue to head north, though, it could be 2007 before cancellations begin to drop, Tomnitz said. Difficulty securing financing has traditionally been a top reason for buyers to cancel. A February survey by the NAHB found cancellation rates up by a third over historically low levels a year ago, and respondents attributed 33 percent of cancellations to buyers' inability to qualify for a loan. That was topped, though, by 44 percent of cancellations due to buyers who couldn't sell their existing homes.

In most cases, those buyers leave their deposits—which can reach as high as 10 percent of the purchase price—when they cancel. (In California, builders must return the deposits.) That's softening the blow for some builders, who can use the cushion to offer discounts and incentives to sell the cancelled homes, says UBS analyst Margaret Whelan.