Homebuilders outlook: glass half full or half empty?

In the past week, there were some positive news releases for the housing market and homebuilders. The government released its April data on new residential sales, and Toll Brothers (TOL 21 ****) posted favorable results for its fiscal second quarter.

On May 24, the government put out some of the best new single-family home sales numbers in a while, up 7.3% versus March, and some would suggest that we may be coming to a stable point for sales and maybe even prices.

The takeaway from the April new single-family homes number is that this metric is potentially positive for homebuilder closings and deliveries in the months ahead.

On May 25, Toll Brothers reported that it signed $521 million in new gross contracts for the April quarter, an annual increase of 6% both in dollars and in units. TOL also posted record low cancellations of only 3.9% (current quarter cancellations divided by current quarter gross signed contracts), compared to 5.3% in last year’s April quarter.

The takeaway on TOL’s positive results on gross contracts and cancellations might be that trends are improving for new home sales and homebuilders. However, I believe TOL is in a unique part of the market, servicing the luxury segment. Generally, most of the company’s prospective homebuyers have remained employed during the economic downturn, and generally have solid credit profiles that enable them to secure mortgages at today’s low rates.

For most homebuilders servicing either first time or first move-up homebuyers, I think the cancellation rate, which reduces gross orders, tells another story. The cancellation rate for DR Horton (DHI 11 **) in the March 2011 quarter was 25%, versus 21% in the prior year’s quarter. In my opinion, the high cancellations may reflect prospective buyers not qualifying for a mortgage or not being to sell their existing home either because of weak demand or the appraised value being below the existing mortgage on the house they are trying to sell.

Most of the other publicly traded homebuilders that I reviewed had cancellation rates not like TOL, but mostly in the mid- to upper teens as a percentage of total gross orders. There were also two other builders that had cancellation rates higher than DR Horton, namely M.D.C. Holdings (MDC 26 ***), at 32%, and KB Homes (KBH 12 **), at 29%. I believe this suggests a housing recovery is not going to happen very soon.

The posts on this blog are opinions, not advice.
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