On Nov. 20, the residential real estate industry seemed to finally get an unexpected dose of much-needed good news. After four consecutive months of declines, the number of new homes being built crept up by a stronger-than-expected 3% in October, according to the Commerce Dept.
But on closer look, the October numbers may just be an aberration. Building permits, an indicator of future construction, plunged 6.6% as homebuilders faced mounting inventories of unsold homes and sluggish demand from buyers.
The annual rate for houses and apartments rose to just over 1.2 million in October. But the rate for single-family homes dropped 7.4% to 884,000—the lowest level since the early 1990s. Overall, the pace of groundbreaking dropped 16.4% from October, 2006. The small increase in overall housing starts in October was driven by multi-family dwelling starts, which tend to fluctuate widely from month to month.
A Lack of Confidence
"I don't think there's any good news in the numbers," said Celia Chen, Director of Housing Economics at Moody's Economy.com. "The builders are still pretty pessimistic."
Builders' confidence sank this year as contract cancellations grew and banks tightened requirements for home loans. The National Association of Home Builders/Wells Fargo Housing Market index, which measures builder confidence, held steady in October and November at 19, a record low. The index was on the rise in late 2006 and early 2007, reaching 39 in February. Readings below 50 mean more builders see market conditions as poor than favorable.
Chen said she expects the drop in housing construction to wipe away 1% of gross domestic product growth this year and next, but there might be some good news for buyers. Builders are not just scaling back new home production, they're slashing prices. The new home discounts are so great in many parts of the country that existing home prices can look unrealistic by comparison. Moreover, in many parts of the country new home sales have actually fallen below existing home sales.
Paying More for the Lived-In Look
Until recently many buyers were willing to pay a premium for owning a new home where the bathrooms, kitchen, and bedrooms have never been used. But that premium is vanishing and is even reversing in favor of existing homes in parts of Florida, Las Vegas, California and other over-built areas throughout the nation.
That has pressured many builders such as Ryland (RYL), Meritage Homes (MTH), D.R. Horton (DHI), and others, to make deals. In some cases, builders have trimmed prices to such an extent in the second half of 2007 that buyers in many markets are actually paying less per square foot on average for new homes than used homes, according to data from HousingIntelligence.com, a Web site operated by housing research and advisory firm BlueSmoke.
New homes tend to be larger and include more bathrooms, sunrooms, and other amenities, as well as new roofing, wiring, and plumbing. They constitute a small fraction of the housing market. Existing homes make up the bulk of the market and their prices, on a square foot basis, were dropping at a slower pace even as demand for housing was drying up and concerns deepening over foreclosures and defaults by subprime mortgage borrowers.
A Smaller Square Foot
"It boils down to simple psychology," said Jonathan Smoke, president and founder of HousingIntelligence.com. "If households live in existing homes that are on the market and can avoid having to sell [for job transfers, bankruptcies, and other life changes] then they will sit tight rather than take a hit to equity. Builders need cash to pay subcontractors and suppliers, to continue development, and pay their debts. In many circumstances, a builder can take a loss to get rid of inventory."
The median price per square foot for a new home nationally dropped 12% to $123.71 in the four months ending in August, according to Smoke's company. Existing home prices during the same period rose 2% to $129.95 per square foot. The HousingIntelligence.com report included data for 194 of the nation's 363 metropolitan statistical areas, including most of the communities where boom-time construction was rampant, Smoke said.
Builders these days are willing to negotiate on price and will often throw in extras such as granite countertops, upgraded flooring, and subsidized loans to close a deal. Still, buying new isn't necessarily cheaper; the cost of a home depends on its location, your negotiation skills, and the dynamics of an individual market, including the number of unsold homes in a builder's inventory. New home bargains can be found, especially in California markets where developers have been making sizable price cuts.
Watching the Economy
Builders are "willing to sweeten the deal because buyers are uncertain," said Michael Castleman, chief executive officer of Metrostudy, a national housing research firm based in Houston. "It's a good time to buy because you're going to get a better deal today than six or nine months ago. The question is will the deal be better tomorrow? That's the risk."
Castleman said the price advantage of buying a new home is temporary and will end once re-sellers are forced to reduce asking prices. So far, the relatively strong economy is preventing a large decline in existing home prices, he said. If the economy goes south, "People will end up losing their jobs and getting jobs in another city at which point they'll be anxious to sell and get a house in a new city," Castleman said. "Resale values will then drop dramatically."
Richard DeKaser, chief economist of National City Corp. (NCC) said the new home prices in certain markets aren't necessarily bargains. And existing home prices may not have adjusted downward yet. "Maybe they're just not succumbing to market realities," DeKaser said of resellers. "Historically, if you look at how property prices respond in moments like this, there is a 6 to 12 month lead time. New home prices change before [prices for] existing properties."
Bonuses for the Agents
Pierce Haney, a Realtor with RE/MAX Capital City in Austin, Tex., said the reasons for the shrinking gap between new and used homes vary from place to place. In Austin, many older homes are in the vibrant downtown where buyers pay a premium to live. But builders have been building on cheaper land, away from the city, and now have to work hard to attract buyers. They're not only offering incentives to buyers, they're giving agents special bonuses and free vacations for bringing in buyers.
"If you could sell about five new homes next month as a Realtor, you could probably take a trip to Paris, a cruise to the Caribbean, a trip to Australia and an all expense paid trip to Las Vegas and still make a commission on top of that," Haney said.
Click here to find out the worst markets for new home sales in the U.S.