by Calculated Risk on 3/20/2008 02:33:00 PM

Dow Jones reported today that the average home builder cancellation rate is currently 43%.

From Dow Jones: For Home Builders, Cancellations Create Expensive Problem (no link yet)

Many contracted buyers, spooked by falling home prices or suddenly unsure of their financial state, are fleeing before closing. The average cancellation rate now tops 43% - leaving builders saddled with even more unplanned, unsold and unwanted homes.

Unfortunately the article doesn't provide the cancellation rate for previous periods, other than to state "the average cancellation rate dipped slightly in the fourth quarter".

The data I compile (probably a subset of the Dow Jones data) shows the cancellation rate dipped slightly to just below 40% in Q4, from a peak of 42.5% in Q3 2007.

Cancellations rates are important when following the reported new home sales and inventory from the Census Bureau. The Census Bureau doesn't include cancellations in their report.

The actual sales could be calculated as total houses sold minus cancellations in the month. The total houses sold would include new sales, plus sales of houses cancelled in previous periods.

We could write this as:

Total Sales = Sales(new) + Sales(Previous cancellations) - Cancellations

But the Census Bureau reports sales as Sales(new) only, and they ignore both factors of cancellations (if a house was sold previously, then cancelled, then resold, it isn't included in the sales numbers). This works fine as long as cancellation rates are fairly steady.

However, with rising cancellation rates, the Census Bureau overstates sales, and understates the increase in inventory (or overstates a decrease in inventory). For cancellation adjusted inventory, see my post: Housing Starts, New Home Sales and Cancellations

The opposite is also true: during periods of declining cancellations, the Census Bureau under reports sales, and overstates inventory. This will be very important in the coming year, since cancellation rates will likely decline as builders require larger deposits and take other steps to avoid cancellations.