I’ve been in real estate for over 25 years. I’ve pretty much seen it all — but I can confidently say I’ve never seen anything like what we’ve seen happen with the housing market over the last couple of months.
At the beginning of June, customers wanted to buy homes in such extreme demand that builders were managing interest lists and making them patiently wait their turn in line. Just a few weeks later, interest lists were a thing of the past — nobody wanted to buy a home, to the point where builders had to begin offering incentives to make them interested. We did a complete 180 in less than a month. The Federal Reserve delivered the biggest interest rate hike in decades to combat the inflation surge. What happened?
We have a unique glimpse into housing market data across the US, and we’ve been tracking this substantial shift in an attempt to understand what’s next and how builders should proceed now.
Where the Market Shift Began
The market has flipped faster than anyone thought possible. In the simplest terms, economists agreed the Fed denied inflation was happening at the pace it was earlier this year. It got ahead of them, and they had to act more severely in the second quarter. When they waited too long to do anything about it, the only solution was to raise the cost of capital and rates really fast and multiple times. When the Fed was so aggressive with raising the interest rate, the 30-year mortgage followed, and a home went from a payment of $1,700 to suddenly $2,150 in a matter of just 30 days. Many of the people who were buying just a few months ago can’t afford to buy a home now or no longer feel comfortable doing so.
Now, builders see appointments convert to sales and think the market is better than it actually is — but they might not be looking further upstream where fresh leads are initiated. Most analysts and builders don’t focus on the pipeline of customers that far up, but the new lead numbers have plummeted. They’re being fooled into thinking things are okay when really, they should be changing their course of action and accounting for this massive shift.
What’s Happening in the Home Building Space
Our ability at New Home Star to track inbound leads, leads that convert to appointments, and those that convert to sales enable us to closely track this market change pattern. Before this shift, new home builders were selling homes to customers at a time when demand far exceeded supply. All these homes a builder sells typically take anywhere from 9-12 months to create. The customers who’ve signed a contract and paid earnest money for their new home that hasn’t been built yet are in the backlog.
The profit margins in the backlog are as healthy as most of these companies have ever had. Imagine you own a home building company and need to sell your homes at a 20% gross margin to end up with the amount you need — these builders have 32-35% sitting in backlog, and they have extra profit margins added into homes they need to build and close.
Builders want to keep selling homes, but high prices are no longer affordable to customers because the rates have gone up. They can drop their sales price, but they won’t. They’re afraid of letting customers in the backlog see them lowering their prices for fear they will cancel their sale. Builders are in a tricky position of needing to figure out how they can give an incentive to a new buyer but also do it secretly — so others in the backlog don’t find out.
As a result, funny trick incentives have surfaced, and builders are working behind the scenes, so any new buyer or customer in the backlog doesn’t discover them. Six months from now, builders will start putting incentives out there loud and proud — $100,000 or $50,000 off — because they will have worked through their backlog and won’t need to hide it from anyone.
Right now, builders have found themselves in a scenario like one I’ve never seen in my long career. What’s their best next step?
A Few Ways to Combat This Change
Builders need to make the homes more affordable to new buyers without compromising the margins they have in their backlog. That means they cannot do price cutting to drive affordability. Instead, one of the most obvious next steps would be to buy down interest rates to put people back in a position of interest rates closer to where they were before.
Builders can also reduce the cost of ownership in different ways. This can take on different forms depending on where in the country you’re selling. They could forward-pay HOA fees for a year or two, prepay mortgage insurance, include free, prepaid, or credited pest control or snow removal, or consider any number of other offerings that would cost a customer money. Builders are best off taking the same amount of money they’d remove from the price and apply that instead to prepaying the cost of ownership.
Builders who don’t operate in this way over the next few months will see major cancellations. Customers will eventually realize they’ve paid too much and discover the secrets of others paying less. We’ve already seen the highest cancellation rate on new homes that we’ve seen in 2.5 years, so now’s the time for builders to get thoughtful about how to maintain customer relationships and keep them invested.
