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.
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.