Home builders up ante to lure buyers
Home builders up ante to lure buyers
Incentives, discounts are pervasive as market slows and inventories climb
By John Spence, MarketWatch
Last Update: 4:16 PM ET Oct 13, 2006
BOSTON (MarketWatch) -- Large home builders are dangling out more incentives to reluctant buyers as the roof caves in on the U.S. housing market. To entice customers, companies are serving up deals that include a free pool, a fancy kitchen or even a new car. But real-estate brokers say all buyers want is a cheaper house.
In September about 77% of home builders were offering some sort of sales incentive in response to spiking inventories, compared with 58% a year earlier, says Gopal Ahluwalia, staff vice president for research at the National Association of Home Builders.
The NAHB found 55% of companies were offering home-option items such as granite countertops and landscaping at no charge, up from 37% the prior year. About 43% were offering to pay the closing costs on the buyer's previous home.
Forty-four percent of builders were reducing home prices, 4% were including a new car with the home and 5% were offering a free holiday trip. Underscoring the sharp pullback in the housing market, the NAHB didn't even bother to poll builders on those three questions last year.
"Inventories are at all-time highs, mortgage rates are still relatively low and prices are coming down, so this is certainly a buyers' market," said UBS analyst Margaret Whelan in an interview.
After the housing market peaked in 2004 and 2005, she said many large builders were caught with unsold inventories, which have bumped up even more due to cancellations. The companies that built so-called speculative or "spec" homes in an effort to squeeze every drop from the housing boom are now in the most trouble.
Whelan said in this tougher housing market, the main focus for builders is finding the right balance between sales volume and profit margins, or quantity versus quality. Some builders that have increased the use of incentives, such as Lennar Corp., have seen their new-home orders fall relatively less, but analysts worry the strategy could hit margins.
Builder stocks, which are seen as a leading indicator for the housing market, have bounced back recently on easing interest-rate concerns and lower bond yields. Yet the Dow Jones U.S. Home Construction Index is still off about 20% over the last 12 months. Investors are now closely watching inventory levels and the stocks could rally once they see signs of the market working through the excess, Whelan said.
Free goodies
Some of the more common incentives being offered to close deals include finished basements or attics, better flooring, lighting and landscape packages, free appliances or favorable financing terms.
Jim Gaines, research economist for the Real Estate Center at Texas A&M University, said add-on incentives such as appliances or wood-trim upgrades are cheaper and easier for new-home builders, while straight price reductions are more common in existing-home sales. Incentives aren't advertised as price reductions, but rather a buyer getting more for the same price.
"Home builders are generally using incentives now just to make sales happen," said Todd Vencil, analyst at BB&T Capital Markets.
The more-speculative markets in recent years such as California, Florida and some other coastal areas are seeing the most incentives because inventories and cancellations are the highest.
"Inventory does not ripen or get better with age, so the builders just want to move it," said Vencil. He said he's heard the stories about some sellers offering free cars, which highlights how desperate some developers and builders are to attract buyers.
"You see incentives in every market -- they're a marketing tool to get in front of customers," the analyst said. "However, there's a difference between incentives for marketing purposes, and incentives to dump excess inventory."
Among public builders, many analysts point to Lennar as the biggest user of incentives to protect its sales pace.
"As we've continued to see weakening conditions in many of our strategic markets, we're experiencing slower sales, higher cancellations, and greater use of incentives and discounting," said Lennar Chief Executive Stuart Miller during the company's latest quarterly earnings call.
He said Lennar's goal is to focus on cash flow at the expense of maintaining profit margins.
"The best way to generate cash flow is to deliver our inventory, completed homes, homes under construction, and developed land by reducing price to market pricing and converting inventory to cash," he said. "We have rigorously pursued this objective by using incentives and price reductions to sell homes and to back-fill cancellations."
In its third-quarter 10-Q filed Oct. 10, Lennar said gross margins on home sales dropped to 18.7% in the quarter from 26.3% a year earlier, largely due to incentives.
During the company's late-September conference call to discuss third-quarter results, management said sales incentives represented 10.1% of a home's value, up from 2.5% the previous year.
On the other hand, analysts say luxury builder Toll Brothers Inc. is an example of a company that's sitting tight on price cuts and incentives because it focuses on the higher-end market.
"Toll Brothers' unusually high price points and accordingly harder-fought land positions tilts the company in the direction of holding the line on price, rather than volume," wrote Citigroup analyst Stephen Kim in a research note.
Toll Brothers CEO Robert Toll in the company's last quarterly conference call said speculative buyers are now turning to sellers, so other builders that built spec homes are trying to move them by offering large incentives and discounts. He said reduced pricing is a "last resort" that Toll has not yet turned to.
Citigroup's Kim said over the past three quarters, most of the builders have shown a willingness to accept dramatically lower sales volumes in order to hold the line on price.
"KB Home and Standard Pacific are among those builders that have aligned themselves with such a strategy," Kim wrote.
"On the other hand, Lennar has clearly moved in the opposite direction -- maintaining higher volumes than its peers by 'pricing homes to market,'" he said, noting that D.R. Horton Inc. has also leaned toward this approach.
D.R. Horton Chief Executive Donald Tomnitz at a recent investment conference said he thinks 2007 will be characterized by continuing incentives to move the existing inventory, which has largely been created by the speculators and investors having gotten out of the market.
"Why are they out of the market? Because they can't contract to buy a home today and resell it for 15% or 20% more," he said.
With cancellations up and inventories growing, Tomnitz said D.R. Horton is trying to negotiate with buyers to close homes, noting "a bird in the hand is worth two in the bush."
'180 degrees from last year'
Delores Conway, director of the Casden Real Estate Economics Forecast at the USC Lusk Center for Real Estate, said builders in California have gotten more creative with incentives. Aside from new cars, some have been offering to pay to have a stager come to the previous home to help improve its appearance to enhance the sale value.
"The good news is most builders have recognized the market has softened and they've stopped building," she said. "The buyers' expectations have changed a lot -- they're afraid of buying at the high point of the market, so they feel it's to their advantage to just sit and wait."
In Arizona, another hot market that's pulled back, almost every builder is offering up extras to sell homes, said Edward Maddox, a realty agent at Keller Williams Realty Southeast Valley. He pointed out, though, that buyers are required to go through the builders' own mortgage companies to get financing perks like lower mortgage-interest payments.
Ryland is running a "quick move-in" promotion, common among builders, in the Denver area that includes pricing incentives as high as $60,000 and backyard landscaping when using Ryland Mortgage if the sale closes by the end of the year.
Maddox said one regional builder this summer offered a new Honda Civic if customers purchased a home during the month of July. Also, some companies are increasing incentives to brokers to as much as 10% of the price of a home.
"They'll give you anything to sell the home," Maddox said. "It's 180 degrees from last year."
Yet Maddox and some other brokers said simple price discounts pique buyers' interest more than gimmicky marketing incentives such as a free washer or dryer.
"Most buyers are focused on lowering their monthly payments, and a new car doesn't help with that," Maddox said.
