Housing, the Economics of Builders, and Negotiating a Deal.

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Housing, the Economics of Builders, and Negotiating a Deal.  

 

Considering the purchase of a new home, but concerned about falling prices and negative equity?    With a little thought you may still be able to get the house you want and sleep well too.  

 

I recently advised a real estate transaction for a family friend.  This may be somewhat of a unique situation, but something to consider.

 

 

Summary of the Situation

 

The Buyer, a family friend, lives in a very nice well established neighborhood, but was interested in a slightly bigger new house.  They were interested in a newly developed (unfinished) subdivision.  By unfinished I mean there are empty lots existing (about 1/3 remain).  One of the builders offered to purchase the buyers house if unsold by closing.

 

 

Housing Summary

 

Supply will increase in the near term as foreclosure stalls pick back up. Increasing unemployment which currently stands at 9% and likely to increase to 12%, promises to depress housing demand further.  Increasing unemployment has a twofold effect-it increases foreclosures and decreases mortgage qualifications which reduces demand.  Reversion to normal lending standards, means there are less qualified home buyers, many of whom are currently in a negative equity situation and therefore won’t sell or can’t refinance.   Shadow inventory e.g. homes near foreclosure, bank owned homes not yet listed, homes taken off the market by homeowners waiting for a more favorable market, etc., have not yet saturated the market, but will-which will only increase downward pricing pressure.  With all the uncertainty does it make sense to buy a new home right now?  I think with a little thought, patience, and selectivity the answer is yes.  

 

 

Builders

 

Many builders have way too much vacant land-equal to several years of inventory based upon the builders previous 12 month unit sales.  This is manageable when volume (units sold) are reasonable and sales prices are increasing.  However this is no longer the case and many builders are having a difficult time funding land holdings.  

 

As land values fall, so too must the selling price of existing home inventory and new builds.  Builders are doing what they can to resist negative price competition.  But for builders to reduce vacant, non-performing, inventory, i.e. vacant lots, they must continue to sell (existing complete or near complete) standing inventory before they can start to eat into vacant lots.  Prices must give and builders face increasing pricing pressure from existing home sales, foreclosures, short sales, and the like.  Builders are also getting pressure from lenders to remove excess capacity as quickly as possible.  Land values are certainly in many areas in decline.  Material costs like cement, wood, and other essentials have come down over the past 12 months.  In many cases, houses that are standing currently as unsold inventory were built with materials purchased months ago.  These costs have come down so the cost to build the next house costs the builder less.  Good for the buyer, bad for the builder.  Knowledgeable buyers will not pay more when they can pay less, but builders again are resisting the loss.  No doubt, builders are happy to transfer their problems onto unsuspecting home buyers.

 

 

Pricing

 

New developments often have several builders to choose from.  Builders of similar or equal quality must price their houses competitively.  As one offers buyers more attractive prices, the others must eventually follow-an unfortunate reality to those with decent balance sheets.

 

Many builders are offering “new architecture” that is, smaller, less expensive (to build) houses in attempt to spur unit sales. (e.g. building second story master bedrooms are less expensive to build compared to main level masters bedrooms.)

 

“Green Shoots”

 

I believe the so called “Green Shoots” will turn out to be weeds.    

 

Foreclosures are certain to increase.  In many markets foreclosures have been quickly purchased and quickly taken off the market.  But as more and more of these sprout they will begin to saturate local markets.  Homeowners and builders will soon be forced to price homes in accordance with these foreclosures.  Meaning housing is artificially high.  Both Builders and homeowners are reluctant to lower prices, but will soon have little choice.  The intelligent buyer wishes to avoid overpaying.  With all the uncertainty, you should require an adequate margin of safety.    

 

 

Negotiating with Builders

 

With land values in decline, builders need to reduce empty lots quickly, but can’t.  Meaning you get to call the shots.

 

A few items to keep in mind:

 

Housing in many areas likely have another 5-10% to fall

I suggest you think about the value of a new house as its replacement cost

You have the upper hand in negotiations

Be smart not greedy

 

 

 

Continued in PDF