by Calculated Risk on 10/01/2007 11:40:00 AM

Homebuilders are once again seeing rising cancellation rates. KB Home reported Thursday:

The company posted a cancellation rate of 50 percent during the most recent quarter, down from 60 percent in the year-ago quarter but well above the 34 percent rate in the second quarter of this year.

This is well above the normal range. According to D.R. Horton, the normal range for cancellations (for Horton) is between 16% and 20%. For those trying to analyze the housing market, this means that the inventory levels reported by the Census Bureau are probably too low right now.

The Census Bureau, during periods of rising cancellation rates, overstates New Home sales and understates the increase in inventory. Conversely, during periods of declining cancellation rates, the Census Bureau understates sales. Here is discussion from the the Census Bureau on cancellations. Note: this shouldn't be confused with revisions that are unrelated to cancellations.

Using cancellation rates from several of the publicly traded home builders, we can estimate the actual new home inventory (as opposed to the inventory reported by the Census Bureau). Note: The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart show the reported and cancellation adjusted inventory levels for the hard inventory (excluding the "Not Started" category).

Click on graph for larger image.

At the end of Q2, this analysis shows the Census Bureau is currently understating the hard inventory of new home sales by about 77,000 units. Even though the Census Bureau has shown a slight decline in new home inventory in the third quarter (through August), I expect the adjusted inventory to increase because of rising cancellation rates.

This will be important to follow later in the housing cycle. However, it isn't just the inventory of new homes for sale that will impact the homebuilders. Existing homes are a competing product for new homes, and the record inventory of existing homes for sale will also pressure home-building activity.


This graph shows the year end inventory levels since 1982 for new and existing homes. (2007 numbers are for August).

Inventory levels are at an all time record of 5.1 million units.

The third graph shows the total inventory normalized by the number of owner occupied units (this adjusts inventory for increases in population and household size).


Total inventory is currently 6.8% of the total owner occupied units in the U.S. This is far above the previous peak of 4.7% in the early '80s.

Finally, it's not just the level of inventory that matters, but also the level of distressed inventory. We are already seeing record levels of foreclosures in some states, and IMO it is about to get much worse. I spoke with one of the top agents in San Diego this weekend, and she was analyzing one neighborhood for a client in the $375K to $450K price range. There were 70 listings (very high for that neighborhood and price range), but she was shocked to find that approximately 75% of the listings were short sales, and a similar percentage were vacant. This suggests a flood of REOs in the coming months.