Even hard hit Western housing markets are stabilizing—just look at KB Home's latest cancellation rate

June 22, 2023 ndowd

Those “aggressive” incentives, coupled with house price cuts, seem to be working for the giant homebuilder: On Wednesday, KB Home reported a second quarter cancellation rate of 22%. While that’s still a high share of buyers canceling their contracts with KB Home, it’s far below what it had said in January and the 36% it had reported for Q1 2023.

“The improvement in [housing] demand we started to see in February was sustained throughout our second quarter, as we achieved monthly sequential increases in our net orders,” Mezger told investors on Wednesday. “We are well-positioned to achieve our revenue target for 2023.”

What’s going on? Two things.

First, the national U.S. housing market stabilized this spring, as a shortage of existing home inventory and seasonality did just enough to put the market back into equilibrium.

Second, builders like KB Home have gained an edge over the existing/resale market. During the Pandemic Housing Boom—a time with seemingly unlimited housing demand—builders achieved frothy profit margins as they quickly raised new house prices. Those expanded margins are coming in handy for builders: As mortgage rates spurred a housing downturn last year, builders like KB Home had the breathing room to reduce margins (i.e. cutting prices and/or aggressive rate buydowns) in pursuit of finding the market, or the price at which buyer demand would return. Those rate buydowns now give builders an edge over average Joes trying to sell their houses.

Among publicly traded homebuilders, KB Home was hit particularly hard by last year’s rising mortgage rates. The reason is that KB Home’s business is concentrated in West and Southwest housing markets, where the home price correction was sharp in the second half of 2022.

In fact, 81% of KB Home’s business is in either the Southwest (51%) or along the West Coast (30%). To make matters worse, KB Home had a high share of business in fast-correcting markets like Las Vegas (which makes up 12% KB Home’s business) and Austin (which makes up 10% of KB Home’s business).

While Austin is still undergoing a home price correction, many Western and Southwest markets are finally starting to stabilize. Indeed, home prices are up this spring in places like Sacramento and Las Vegas. That stabilization, of course, is helping KB Home.

There’s also a growing optimism on Wall Street that incentives, like mortgage rate buydowns, will continue to give builders an edge in not just 2023, but also as long as mortgage rates stay elevated. After all, not only are builders able to offer incentives, but they’re also facing limited competition as existing home supply remains tight amid the so-called “lock-in effect” as homeowners refuse to sell and lose their long-term 2% or 3% mortgage rates they got before interest rates started rising.

That builder enthusiasm has translated into a rush among investors to buy shares in homebuilders, including a 60% year-to-date jump in the share price of KB Home. Other major builders are also up big this year, including PulteGroup (up 70% year to date), Toll Brothers (up 50.7% this year), Lennar (+32.2%), and D.R. Horton (31.2%).