Is the Housing Market Cooling Down?

The rally of the housing market seems to have lost some of its momentum in recent months: The growth in housing prices have slowed down, and leading home-builders’ stock have sharply declined in the past several months: Shares of D.R. Horton  (DHI) have decreased by over 19% between April and September. Looking forward, will the housing market continue to cool down? If so, what does it mean for leading home-builders in terms of growth in revenues in the coming quarters? Let’s explore these issues. 

Is the housing market cooling down?

Let’s take a close look at several key factors that could suggest the housing market is cooling down:

Home sales aren’t growing as fast as they did earlier this year: Based on the U.S Census Bureau’s report (PDF file), new home sales ranged between 390k and 458k in the past several months. These figures are higher than last year but didn’t grow significantly during 2013. Moreover, in the previous month, home sales reached their lowest level this year. The chart below shows the changes in new home sales and average new home prices.

new home sales  September 2013

Source: U.S. Census Bureau, Department of Housing and Urban Development

The chart above also leads me the next point: Home prices. The chart above also shows that the average price of a new home has sharply declined in the past several months. Moreover, based on the latest S&P/Case-Shiller Home Price Index report, prices rose at slower pace compared to previous months: During July, the index slightly increased by 0.6%. In comparison, during June the index rose by 0.9%.

If home prices don’t rise as fast as they did earlier this year, this could also suggest the housing market is slowing down.

Another factor to consider is mortgage market: According to the Mortgage Bankers Association, mortgage applications increased in three out of the last four weeks. The recent rally in mortgage application coincided with the fall in mortgage rates. But this recent rise in mortgage applications could slowdown: The decision of the FOMC to maintain its asset purchase program including the $40 billion a month mortgage backed securities back in September may have contributed to the latest rise in mortgage applications. Looking forward, the FOMC will eventually cut down its asset purchase program, perhaps next year; this decision is likely to pull down the demand for homes as mortgage rates will rise again.

Despite the potential slowdown in the housing market, homebuilders are likely to maintain high growth in revenues in the coming quarters. The main is the high backlog of leading homebuilders. Sales order backlog represent homes under contract but not yet closed as of the end of the quarter. Higher backlog is likely to result in higher sales in the coming quarters. Let’s examine the backlog of some leading home builders.

D.R. Horton recorded nearly 10 thousand homes in backlog as of the second quarter of 2013 – a 36% spike compared to the same quarter in 2012. The value of these homes rose by 56%.  PulteGroup (PHM) also recorded a 13% growth in its backlog units and a 25% increase in these homes’ value. The growth in backlog is mostly in North and Florida. In comparison, this company’s revenues rose by 19.6% in the second quarter. Most of its growth was in sold units in Texas and the North.  Lennar (LEN) has also experienced a sharp rise in houses in backlog: In the third quarter, backlog reached 5,958 homes – a 32% increase. These homes’ dollar value jumped by 53%. Moreover, in the past quarter, the company’s revenues increased by nearly 46%. Most of the growth in sale came from the East. In terms of cancellation rate, it is only 18% – lower than D.R Horton’s rate.

But not all backlog homes will result in a sale, some may be cancelled. The rate of canceled home sales as percentage of total backlog contracts is called cancellation rate. These companies could experience some slowdown in growth in sales if their cancellation rates rise. The rise in cancellation rate could be due to the following: A decline in existing home sales (buyers aren’t able to sell their homes to enter the new home), fewer mortgage loan approvals, higher mortgage rates.  The cancellation rate of these companies may rise in the coming quarters. In such a case, this could result in a reduction in the high growth in backlog of homes.

D.R. Horton’s sales order cancellation rate was 24% in the second quarter of 2013. Based on sales order backlog, prices and cancellation rate an outlook for future revenues could be made. Assuming prices will rise by only 10% and based on current cancellation rate, the company’s growth in net sales orders could range between 20% and 25% in the coming quarters.

The bottom line

Despite the slowdown in the housing market, as indicated above by the stagnation in home sales, slow growth in home prices and potential rally in mortgage rates, home-builders are likely to pass through this slowdown and maintain their high growth in revenues in the coming quarters. The rise in mortgage rates could eventually lead  to higher cancellation rate, which could also result in higher rates.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.