“When I say reset, I’m not looking at a specific set of data. What I’m saying is that we have a period of a hot housing market across the country, where the prominent houses are sold to the first buyer for 10% above the asking even before seeing the house… The term we need is supply and demand to be better arranged so that housing prices rise to a reasonable level and at a reasonable pace and that people can buy houses again. Maybe we in the housing market have to go through a correction to get back to that place,” Powell said. “But from a business cycle perspective, it’s tough [housing] The correction should bring the housing market back into better balance. ”
Of course, this is called “hard [housing] correction” has arrived. Look no further than its latest earnings report KB House, one of the nation’s largest publicly traded homebuilders.
On Wednesday, KB Home announced that its buyer cancellation rate fourth quarter of 2022 increased to 68%. That’s up 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 buyers more cautious since the middle of last year. That said, in fourth quarter, we prioritized delivering our large backlog and protecting our high margins rather than taking steps to stimulate additional sales during this slow period,” KB Home told investors on Wednesday.
Historically, the 68% cancellation rate is off the charts. Even in the darkest days of the 2008 weather crash, the average builder cancellation rate reached only 47%.
What happened? Affordability pressure—a 3 percentage point mortgage rate jump is next a +40% run-up in US house prices—sent a shock wave through the US housing market. Some buyers cancel their contracts because they fears that house prices will fall further in 2023; others simply lost their mortgage eligibility in the face of 6% mortgage rates.
Rising cancellation rates put homebuilders in a pickle. The problem: builders still have a lot of inventory—both single-family and multi-family—in the pipeline. the increase in demand for housing during the pandemic coupled with supply chain issues pushed the number of US housing units built at a record high in 2022.
Going forward, the builders will continue to return to theirs housing downturn playbook to unwind that unsold inventory. They start by offering incentives like buy mortgage rateand if that doesn’t work, then start marking up home prices until their unsold inventory is moved.
“Depending on market dynamics and backlog levels in each community, we are becoming more aggressive in our pricing ahead of the spring sales season, to generate new orders. At the same time, with the industry-wide deceleration in housing starts compared to a year ago, we also aim to reduce direct construction costs and construction times, which will help balance the impact of price changes that we may make,” KB Home told investors on Wednesday.
When it comes to cutting home prices, KB Home is treading lightly. If word gets out, buyers already under contract may become frustrated and cancel their contracts. That reason, combined with wanting to protect their “comps”, is why builders prefer to offer incentives like buy mortgage rate instead of lowering the price.
Real estate agents and builders alike are rooting for easing financial conditions, and a subsequent reduction in mortgage rates.
If mortgage rates fall, say, favorable news on the inflation front, then affordability may gradually return to the market. If not, as long as affordability remains “pressurized,” the US housing market probably stay in “reset” mode.
Researchers at companies like Goldman Sachs and Moody’s Analytics not as optimistic when it comes to mortgage payments. Both companies expect mortgage rates to hover around 6% this year, and both companies expect US home prices to continue falling through 2024.
While the Fed’s housing “reset” indeed there are builders who tremble, this is not a doomsday 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 share prices. That includes builders like DR Horton (+ 78% since January 1, 2020 ), Lennar (+ 73%), Tol Brothers (+34.5%), Aktibistang Positibo (+29.3%), PulteGroup (+25.2%), and KB Home (+1%).
Bank of America Researchers think the bottom of homebuilder stocks may be in the rearview mirror.
“Homebuilder stocks will not do well in 2022 as mortgage rates rise to 7% from 3% and demand worsens in the second half of the year. In 2023, we are cautious on housing demand … due to some reasons: 1. Homebuilder valuations are already pricing in weak demand and declining home prices. Most of the land on balance sheet was purchased before 2021 and we expect a correction in home prices ( less than 10%) than a crash (less than 15-20%). 300 basis points in the tailwind from the tree),” Bank of America researchers wrote on Wednesday.
Bank of America reiterated a neutral rating for KB Home.
“We expect [KB Home] orders to remain under pressure with rising mortgage rates, but headwinds are likely to be seen in the valuation of trading shares,” wrote researchers at Bank of America. “Furthermore, we believe the KBH has some cushion in its margins even though the price has dropped by 40% [of] The ownership of these lots was contracted in 2019 and another 40% was contracted in 2020, before the increase in land prices. However, we believe KBH has the highest risk of write-downs in our coverage due to its high exposure to the unfavorable West Coast [and] farm [West] markets.”
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