“When I say reset, I’m not looking at a specific data set. What I’m saying is that we’ve had a very hot housing market across the country, where popular homes are selling to first-time buyers for 10% above asking even before they see the home. … The term that we need is supply and demand to be aligned so that house prices go up at a reasonable level and at a reasonable pace and people can buy houses again. We probably in the housing market will have to go through a correction to get back to where it is,” said Powell . “But from a business cycle point of view, it’s tough [housing] the correction should bring the housing market back to a better equilibrium.
Of course, this is what I call “difficult.” [housing] correction” has arrived. Look no further than the latest earnings report from KB Home, one of the nation’s most publicly traded homebuilders.
On Wednesday, KB Home announced that the buyer cancellation rate in the fourth quarter of 2022 increased to 68%. It increased 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 continued inflation, along with an uncertain economy, have made homebuyers more cautious since the middle of last year. So, in the fourth quarter, we prioritized delivering a large backlog and protecting high margins rather than taking steps to stimulate additional sales during slower periods,” KB Home to investors there.
Historically, a 68% cancellation rate is off the charts. Even in the darkest days of the 2008 crash era, the average builder cancellation rate only reached 47%.
What’s up? Affordability pressures—a 3 percent jump in mortgage rates following a +40% increase in U.S. home prices—have sent shock waves through the U.S. housing market. Some buyers cancel the contract because of the same fear that home prices will fall further in 2023; others have simply lost mortgage eligibility in the face of 6% mortgage rates.
Spiking cancellation rates put homebuilders in a pickle. The problem: builders still have too much inventory — single-family and multi-family — in the pipeline. A pandemic housing demand boom coupled with supply chain issues has pushed the number of US housing units under construction to a record high in 2022.
Going forward, builders will continue to open up their home playbook to eliminate unsalable inventory. They will start by offering incentives like buying mortgages, and if that doesn’t work, then mark down the price of the home until the unsold inventory has been moved.
“Depending on the dynamics of the market and the level of backlog in each community, we are becoming more aggressive with prices before the spring sales season, in order to generate new orders. At the same time, with the deceleration in the industry at home starting compared to a year ago, we are also trying to a reduction in direct construction costs and build time, which should help offset the impact of possible price adjustments,” KB Home told investors on Wednesday.
When it comes to cutting home prices, KB Home treads lightly. If word gets out, buyers who are already under contract may become frustrated and cancel their contracts. That reason, coupled with wanting to protect the “components”, is why builders prefer to offer incentives like mortgage buyouts rather than lower prices.
Real estate agents and builders were rooting for the loosening of financial conditions, and the subsequent drop in mortgage rates.
If mortgage rates fall, say, good news for inflation, then affordability can gradually return to the market. Otherwise, as long as affordability remains “pressed,” the US housing market will remain in “reset” mode.
Researchers at companies like Goldman Sachs and Moody’s Analytics is not optimistic about mortgage rates. Both companies expect mortgage rates to hover around 6% this year, and both companies expect US home prices to continue to decline through 2024.
When the Fed’s house “reset” certainly has reeling, it is hardly the end of the world for them. Just look at the stock market.
While the major homebuilders are all down from their 2022 highs, they are still higher than their January 2020 stock prices. 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 homebuilder stocks may 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 in housing demand … but we see a more favorable setup for the performance of homebuilder stocks for several reasons : 1. Homebuilder valuations have prices in high demand and the depreciation of housing prices 2. Mortgage rates have declined from the peak level and poised to move lower in 2023. 3. We do not see a material risk to the book value – most of the land on the balance sheet was purchased before 2021 and we expect a house price correction (down 10%) rather than a crash (down 15-20%). 300 basis points tailwind from wood),” Bank of America researchers wrote on Wednesday.
Bank of America maintained a neutral rating for KB Home.
“We look forward to it [KB Home] orders remain under pressure with rising mortgage rates, but headwinds are likely to be reflected in the value of trading shares,” wrote researchers Bank of America. [of] the lot they have is under contract in 2019 and another 40% is under contract in 2020, before land prices rise. Still, we believe KBH has the highest risk of a write-down in our coverage due to its high exposure to the poor West Coast. [and] mountain [West] market.”
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