Rapid house price gains and rising mortgage rates have taken a heavy toll on housing affordability in many areas. As a result, home sales have come off the record highs of last year, and inventories of unsold new homes have climbed in the process. Cancellations of prior sales have moved up as well, compounding builder problems at a time when hikes in short-term rates have boosted the cost of carrying inventory.
Sales cancellations could go much higher if investors/speculators walk away from contracts signed during the buying frenzy of 2005; indeed, we are already getting reports of cancellations by these types of buyers in some of the hot markets. Investors/speculators may also unload units back onto the markets if price appreciation appears to be faltering, further eroding the supply-demand balance in many areas. In this highly uncertain environment, builders obviously should be very cautious about starting units that have been permitted but not yet sold, and they should pull out the stops to limit cancellations.
INVENTORY TRENDS According to the Census Bureau, the inventory of new homes for sale reached a record level in January, and the supply (at the January sales pace) moved above five months for the first time in almost a decade. Furthermore, the median length of time that completed new homes were sitting on the market moved up to four and a half months.
The Census Bureau's new-home inventory estimates include units that are for sale but not yet started, which takes some sting out of the inventory “overhang.” However, the inventory of units completed or under construction also is at a record level. Furthermore, sales that are subsequently canceled never get back into the government's inventory estimates, and it's clear that cancellations have been rising.
In February, the NAHB surveyed nearly 500 single-family builders about unsold inventories (excluding units not yet started but including units handed back to builders through cancellations). More than one-third of the respondents said that their inventories were higher than six months earlier, while fewer than one-fifth said that their inventories had come down over that period. The net percentage reporting higher inventories was particularly high in the West and among builders starting more than 25 units per year.
SALES CANCELLATIONS Also, 20 percent of builders said that their cancellation rate was higher in January than six months earlier, while only 8 percent said that their cancellation rate was down over that period. Reasons for cancellations, in order of importance: buyer could not sell an existing home (45 percent); buyer could not qualify for a loan (33 percent); buyer decided not to purchase a home (33 percent); change in family circumstances (18 percent); and change in employment (15 percent).
A supplementary NAHB canvass of large, single-family home builders showed that, in January, cancellation rates (cancellations as a percentage of sales backlog) were up by about one-third, on average, from historically low levels a year earlier. That trend, if it continues, accentuates the need for builders to control speculative building during the period ahead and to employ incentives to support sales and limit cancellations (see “Reality Check,” March, page 100).
Chief Economist, NAHB Washington, D.C.
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