Homebuilders Boost Buyer Incentives to Increase Sales

As the key spring U.S. homeselling season approaches, buyers are finding deals on new houses as builders focus on boosting revenue.

Dwayne Saunders purchased a house in Eastvale, California, in December, paying $450,000 after builder D.R. Horton Inc. cut the price by 4.5 percent, threw in a washer-dryer and covered his closing costs.

This month, the house next door sold for $404,000.

“It was bigger too,” Saunders, an office manager who lives with his family of five, said during an interview in his driveway. “I think D.R. Horton just wanted to finish this phase and move onto the next one.”

U.S. builders are trying to increase earnings by selling more houses, even if it requires freebies to draw customers such as Saunders. That’s creating more of a buyers’ market for new homes after a 46 percent jump in prices in four years -- and denting housing companies’ profit margins at a time when land and labor costs have also jumped.

“The pressure is they need to generate volume,” Robert Curran, a managing director at Fitch Ratings in New York, said in a telephone interview. “They can’t assume these margins will grow further or even sustain. So if they want to generate improved profitability, they need to sell more homes.”

Sales of new houses are strengthening after choppiness last year, with purchases last month reaching the highest pace since 2008, Commerce Department data showed Tuesday. Single-family home starts are expected to increase 26 percent to 804,000 units this year -- the highest pace since 2007 -- as job growth, rising consumer confidence and low mortgage rates spur demand, according to the National Association of Home Builders.

Adjusting Prices

To keep volume up, homebuilders will need to make prices attractive as buyers get more to choose from. Some companies have adjusted by offering discounts and lower-priced homes. Others are stuck with higher-cost land that makes it hard to offer discounts while maintaining profits. The Standard & Poor’s Supercomposite Homebuilding Index lost 3.6 percent this year through yesterday, more than the 1.4 percent drop in the S&P 500.

D.R. Horton, the largest U.S. builder by revenue, said this week that it expects a sales increase this year to offset narrowing profit margins as it shifts a bigger share of production to entry-level houses. The Fort Worth, Texas-based company had 12,400 speculative homes, or houses built before finding a buyer, as of Dec. 31. That positions it to quickly meet expected demand -- or offer incentives to sell the properties.

Horton is “adjusting our pricing accordingly, whether it’s down or up,” to meet sales goals for each community, Chief Financial Officer Bill Wheat said on a conference call with investors. The stock rallied 5.5 percent on Jan. 26.

KB, Lennar

Shares of KB Home and Lennar Corp. didn’t fare as well when the builders said their profitability will be hurt by rising costs and shrinking pricing power. The stocks fell 16 percent and 7.2 percent, respectively, on the days of their earnings reports this month.

MDC Holdings Inc.’s gross margin on home sales fell to 16.3 percent in the fourth quarter from 17.4 percent a year earlier as it increased incentives, Chief Executive Officer Larry Mizel said in a statement today.

“Combined with rising construction and land costs, the increased incentives placed pressure on our homebuilding gross margins,” he said.

Stock Downgrades

The decline in builder profitability is “unlikely to reverse soon,” Stephen Kim, an analyst with Barclays Capital, wrote in a Jan. 16 note in which he lowered his ratings on Horton, Lennar and Meritage Homes Corp. That left him with no buys among the seven builders he covers. Michael Dahl, an analyst with Credit Suisse Group AG, followed later with downgrades of Meritage, PulteGroup Inc., Ryland Group Inc. and Taylor Morrison Home Corp. Citigroup Inc.’s Will Randow yesterday cut Horton and Brookfield Residential Properties Inc. to neutral from buy.

Land costs, especially for prime locations, are going up for homebuilders that have worked their way through lower-priced lots purchased after the housing crash. Most public builders -- with the notable exception of Horton, with its Express Homes line starting at less than $100,000 -- have shifted away from the entry-level buyer segment, because those customers have had difficulty qualifying for loans. Now that’s where the supply shortage is most acute and the growth potential is greatest.

“We topped out on the number of people who need $400,000 homes,” said Alex Barron, an analyst with Housing Research Center LLC in El Paso, Texas. “If you got one of those, you won’t need another one for a long time. And if you’re in the market for a lower-priced home, they aren’t available, or you can’t afford it.”

Existing Homes

Builders have the disadvantage of competing with sellers of existing homes, which are cheaper and closer to jobs than many of the new communities on the suburban outskirts. The median price of a new home was $298,100 in December, up from an October 2010 low of $204,200, according to Commerce Department data. For existing homes, the median rose 23 percent in the period to $209,500, according to the National Association of Realtors.

In Texas, which has been one of the nation’s strongest housing markets, builders are rushing to sell amid concern that falling oil prices will dent demand, said Lawrence Dean, a senior adviser in Houston at market researcher Metrostudy. Public homebuilders during the past month have increased incentives, especially in Houston and Dallas, and are building more homes on a speculative basis, seeking to sell as many homes as they can now in case the market cools, he said.

“They may be overreacting,” Dean said. “It’s possible they’re going to leave money on the table as they try to push sales volume unnecessarily so.”

Buyer Comfort

The ability of builders to increase sales depends heavily on the U.S. economy, and that picture is mixed. While low mortgage rates, falling gas prices and the 2.95 million new jobs added last year will bolster buyer finances, wage growth has been feeble, especially for lower-paid workers. Average hourly earnings rose 1.7 percent in the 12 months ended December, the least in two years, Labor Department figures show.

“As soon as people are more comfortable buying homes, you’ll see margins go up,” said Larry Sorsby, chief financial officer of Red Bank, New Jersey-based Hovnanian Enterprises Inc. “What’s going to make consumers more comfortable is getting better-paying jobs, and that’s what’s going to be the catalyst for homebuilders to take off again.”

In setting prices, builders are becoming more adept at responding to shifts in consumer sentiment, credit availability and production pace, according to David Goldberg, an analyst with UBS Securities LLC in New York.

“The builders package deals not so you’ll get the best deal, but so that you’ll feel really good,” he said in a telephone interview. “For all we know, they marked the base pricing of the house up enough so the net pricing wasn’t changing. Part of it’s just psychological, and the builders are great at that.”

Big Deal

At the Trails, D.R. Horton’s 369-lot community in Eastvale, about 45 miles (72 kilometers) east of Los Angeles, the sales team festooned fences with red, yellow and blue balloons and hung banners for its “Big Deal Event,” offering as much as $35,000 off on homes. Before the discounts, the houses were listed from $428,900 to $490,854.

Saunders and his fiancee, Rotundra Greene, were unpacking boxes in their new garage, offering friendly waves to new neighbors who recently bought homes on their street, Cantata Drive in the Trails. The couple, who plan to marry this year, purchased the new home as a place to blend their families -- and because they felt like they got a good deal.

“Builders are giving out great incentives,” Saunders said. “At the end of the day, they sold all but one house on my block.”

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