High Cancellations Confirm Phantom Rebound in the Housing Market

by: Barry Ritholtz

Dan Gross had a good Sunday Times piece on a favorite subject of ours: The Phantom Rebound in the Housing Market. Not surprisingly, it was on canceled new home contracts.

Which brings us to this morning's news:

D.R. Horton (NYSE:DHI) orders tumbled 23%, and cancellations remained high in the fiscal first quarter as the home-building giant continued to struggle with a deteriorating housing market.

The Fort Worth, Texas, builder received net sales orders for 8,771 homes valued at $2.3 billion in the latest quarter, down from 11,463 homes valued at $3.2 billion a year earlier. The decline was slightly better than the fiscal fourth quarter's 25% dropoff.

The decline, however, was larger than the 18% drop Bank of America analyst Daniel Oppenheim had forecast and significantly above the 6% decline rival Lennar Corp. (NYSE:LEN) reported for its fiscal fourth quarter. . .

Cancellations from buyers nervous about the unpredictable and volatile housing market continued to hamper net sales. The cancellation rate was 33% in the quarter, slightly better than the 40% cancellation rate in the fourth quarter. However, Chairman Donald Horton cautioned that the small improvement doesn't indicate that demand is rebounding. (emphasis added)

This is very much in sync with the Sunday Times piece, which cautions that the "improvements" are misleading:

But those who think that the worst may be over for the housing market should take another look at the data, economists say. For the figures on new-home sales have a strange wrinkle that, in the current environment, may lead the government to overstate sales (and to understate inventory) by up to 20 percent. “The market is weaker than the data say,” said Mark Zandi, chief economist at Moody’s/Economy.com.

New-home sales are tallied by the Census Bureau, based on a sampling of contracts signed by home buyers. Running at a pace of more than one million a year for the last four years, new-home sales have been a significant contributor to the housing boom — and to the economy. (Existing-home sales, reported monthly by the National Association of Realtors, count actual closings.)

But here’s the rub: If a contract to buy a home, signed in November, is canceled in December, the Census Bureau does not subtract the failed transaction from the number of sales, or add the house back to its inventory total. In the last year, as the housing market has cooled, the volume of cancellations has risen to epidemic proportions. (emphasis added)

Note that Toll Brothers (NYSE:TOL) had cancellations of 37%, while Pulte Homes (NYSE:PHM) reported a 36% cancellation rate. And as we noted last week, Lennar announced a stunning land-related write-down of $500 million.

The NAR's survey of 30 large builders (November 2006), showed cancellations running at an astonishing 38% of gross sales. That compares with 26% for the same period in 2005, and about 18% 1H 2005. In other words, cancellations are actually accelerating.

How significant are the actual numbers? Dan Gross observes:

On its Web site, the Census Bureau acknowledges: “As a result of our methodology, if conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated.” By how much? Mr. Carson of AllianceBernstein estimates that the government is overestimating the pace of annual sales by 100,000 to 150,000. Mr. Zandi of Economy.com estimates that the differential is even greater. “Given the rise in cancellation rates, it suggests that between 150,000 and 200,000 home sales are being counted that actually did not occur.

There is some good news in the housing area: Mortgage Applications ticked up as rates slid last week. Oh, abusive, high-pressure sales tactics of Ameriquest Mortgage Securities hasn't saved their bacon: Fitch and S&P lowered their investment ratings on their mortgage-pass-through certificates; Other sub-prime lenders have run into troubles, including bankruptcy.

But the most amusing mortgage news is that if you shop around, you can get competitive rates, including: No Mortgage Payment for 12 Months.

I guess that's what some people consider a sign of a bottom: free houses for people who can't afford them.

A Phantom Rebound in the Housing Market
Economic View
NYT, January 7, 2007

D.R. Horton Orders Tumble 23%
WSJ, January 10, 2007; Page C8

Mortgage Applications Up as Home Buyers See a Break in Rates
NYT, January 9, 2007