If You Build It, They Will Come (Or Cancel)

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Key Takeaways:

• Homebuilders are dealing with high cancellation levels. 
• There’s an obvious reason why people are backing out of deals. 
• It comes down to buyer’s remorse over continually decreasing affordability. 

Source: Google Finance 

That’s a look at the YTD performance of the top most searched homebuilder stocks in The Juice’s proprietary Trackstar database. 

Across the board, investors have whacked these stocks evenly, with between 30% and 40% declines. 

Not a major surprise. The writing was on the wall. 

We can use KB Home’s and Lennar Corp’s (LEN) recent earnings reports to illustrate what transpired. 

• Both KB and Lennar beat analyst expectations on earnings per share, but came in just shy of estimates on revenue. 

Hardly terrible numbers, however it’s each homebuilder’s cancellation rate, along with what they expect going forward that’s concerning. 

• Last quarter, 35% of buyers canceled on KB Homes. 
• At Lennar, that number was 21%. 

At both companies, orders are down and appear likely to continue declining. 

• At KB, net orders off roughly 50% year-over-year. 
• At Lennar, new sale orders dropped 12%. 

A big reason for the cancellations and trepidation: buyer’s remorse. 

KB homes made this a specific point during its earnings call:

It was not necessarily that the buyers did not qualify, they did not feel comfortable moving ahead with the purchase.

Makes sense. Look at this way. 

As The Juice noted the other day, in late August, the monthly payment on a 30-year, $900,000 mortgage was $5,393 when interest rates were at 6.0%. 

Just a week later, in early September, that monthly payment hiked to $5,541 at 6.25%. 

Now, as of Tuesday morning, with rates at 7.08%, the monthly payment grows to an even scarier $6,036. 

A $643 monthly payment increase in just a month. 

If you have (too much) time to think, you might back out. 

Digging into Lennar’s conference call, here’s one way the homebuilder appears to be dealing with this conundrum: 

In this market environment, we are not opening communities for sale until models are 100% completed to optimize the selling effort, which contrasts with the past 12 months, during which we opened for presales while models were still being constructed.

Slick move, Lennar. Slick move. Maybe even a little sneaky. 

The Bottom Line: At some point, homebuilder stocks might become too cheap to ignore. KB stock currently trades for a forward P/E ratio of less than 3. For LEN, it’s a hair under 4.5. 

All depends on your outlook on housing, risk aversion, and investment time horizon. 

In any event, what we’re seeing develop with homebuilders gives us a nice reflection on the overall real estate market. 

If you’re sitting pretty with your house paid off or a sub-4%, 5%, or 6% interest rate, you’re likely not going anywhere. This doesn’t necessarily indicate a housing crash on the horizon. Just a stalemate. In fact, it’ll likely contribute to tightening supply. 

So some prospective buyers will ultimately come off the sidelines, willing to pay a premium for both the house and the mortgage they use to finance it, thinking it’s now or never. This will help avoid a doomsday scenario as they keep cooling prices from crashing outright. 

Renters will continue to pay record prices, which can feel like relative bargains when you do the aforementioned math on what it costs to commence and carry a mortgage. 

Strange times, indeed. 

The Juice loves following the data on housing and piecing together the narrative from personal finance and investing perspectives. So, add us to your trusted contacts and feel free to tell a friend.

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