The Fed’s housing market ‘reset’ sees buyer cancellation rate at one of the nation’s largest homebuilders spike to 68%

“When I say reset, I’m not looking at a particular specific set of data. What I’m really saying is that we’ve had a time of a red-hot housing market all over the country, where famously houses were selling to the first buyer at 10% above the ask even before seeing the house… For the longer Term what we need is supply and demand to get better aligned so that housing prices go up at a reasonable level and at a reasonable pace and that people can afford houses again. We probably in the housing market have to go through a correction to get back to that place.” Powell said. “But from a business cycle standpoint, this is difficult [housing] correction should put the housing market back into better balance.”

Of course, this so-called “difficult.” [housing] correction” has already arrived. Look no further than the latest earnings report by KB Home, one of the nation’s largest publicly traded homebuilders.

On Wednesday, KB Home announced that its buyer cancellation rate in the fourth quarter of 2022 spiked to 68%. That’s up from 35% in the third quarter of 2022, and up from 13% in the fourth quarter of 2021.

Current conditions remain challenging. High mortgage rates and persistent inflation, together with an uncertain economy, have made homebuyers more cautious since the middle of last year. As such, in the fourth quarter, we prioritized delivering our large backlog and protecting our high margins over taking steps to stimulate additional sales during this seasonally slower time frame.” KB Home told investors on Wednesday.

Historically speaking, a 68% cancellation rate is off the charts. Even during the darkest days of the 2008 era crash, the average builder cancellation rate only reached 47%.

What’s going on? Pressurized affordability—a 3 percentage point mortgage rate jump following a +40% run-up in US home prices—has sent a shock wave through the US housing market. Some buyers are canceling their contracts because they’re afraid that home prices will fall further in 2023; others have simply lost their mortgage eligibility in the face of 6% mortgage rates.

Spiking cancellation rates puts homebuilders in a pickle. The problem: builders still have a tremendous amount of inventory—both single-family and multi-family—in the pipeline. The Pandemic housing demand boom coupled with supply chain issues pushed the number of US housing units under construction to a record high in 2022.

Heading forward, builders will continue to turn to theirs housing downturn playbook to unwind that unsold inventory. They’ll start by offering incentives like mortgage rate buydownsand if that doesn’t work, then begin to mark down home prices until their unsold inventory has been moved.

“Depending on market dynamics and backlog levels in each community, we are getting more aggressive with our pricing ahead of the spring selling season, in order to generate new orders. At the same time, with the industry-wide deceleration in housing starts compared to a year ago, we are also pursuing reductions in direct construction costs and build times, which should help offset the impact of pricing adjustments we may take,” KB Home told investors on Wednesday.

When it comes to cutting home prices, KB Home is treading lightly. If word gets out, buyers already under contract could get frustrated and cancel their contracts. That reason, coupled with wanting to protect their “comps”, is why builders prefer to offer incentives like mortgage rate buydowns rather than cut prices too much.

Real estate agents and builders alike are rooting for a loosening of financial conditions, and a subsequent drop in mortgage rates.

If mortgage rates fall on, say, favorable news on the inflation front, then affordability could gradually return to the market. otherwise, as long as affordability remains “pressurized,” the US housing market will likely remain in “reset” mode.

Researchers at firms like Goldman Sachs and Moody’s Analytics aren’t as optimistic when it comes to mortgage rates. Both firms expect mortgage rates to hover around 6% this year, and both firms expect US home prices to continue to fall through 2024.

While the Fed’s housing “reset” certainly has builders reeling, it’s hardly a doomsday for them. Just look at the stock market.

While major homebuilders are all down from their 2022 highs, they’re still well above their January 2020 share price. That includes builders like Dr. Horton (+78% since January 1, 2020 ), Lennar (+73%), Toll Brothers (+34.5%), NVR (+29.3%), PulteGroup (+25.2%), and KB Home (+1%).

Bank of America researchers think the bottom in homebuilder stocks could be in the rearview mirror.

Homebuilder stocks underperformed in 2022 as mortgage rates spiked to 7% from 3% and demand deteriorated in the second half of the year. In 2023, we are cautious about housing demand…but we see a more favorable setup for homebuilder stock performance. for a few reasons: 1. Homebuilder values ​​are already pricing in weak demand and home price depreciation 2. Mortgage rates have declined from peak levels and are poised to move lower in 2023. 3. We do not see material risk to book value – Most of the land on balance sheets were purchased prior to 2021 and we expect a home price correction (down 10%) rather than a crash (down 15-20%). 300 basis points tailwind from lumber,” Bank of America researchers wrote on Wednesday.

Bank of America reiterates a neutral rating for KB Home.

We expect [KB Home] orders to remain under pressure with rising mortgage rates, but headwinds are likely already reflected in valuation with shares trading,” wrote Bank of America researchers. “In addition, we believe KBH has some cushion to its margins even as pricing declines given 40% [of] Its owned lots were contracted in 2019 and another 40% were contracted in 2020, prior to the run-up in land prices. Still, we believe KBH has the highest risk of write-downs across our coverage given its high exposure to underperforming West Coast [and] Mountain [West] markets.”

Want to stay updated on the housingcorrection? Follow me on Twitter at @NewsLambert.

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