Home builders are professional marketers and, as such, are the most important “class” of sellers you must watch in your local market. Home builders have a lower costs, answer to a higher authority, and are more sensitive to inventories than Mr.& Mrs. Jones of Perkasie, PA. Let me explain what that means and why it is important to you, the Professional Realtor.
Home builders have a lower cost of funds.
In 1995, builders were a mostly entrepreneurial bunch. They were
regional, smaller, and privately-held. Less than 20% of the home
builders were publicly-owned; their source of capital was debt. Debt
requires servicing and has a lower margin for error in pricing. Hence,
the homebuilders “marked to the market” frequently through drastic
price reductions. They didn’t fear class-action suits from homeowners
because their pricing was necessary to the survival of the company. In
short, they had shallow pockets and did what the banks told them to do.
Homebuilders answer to a higher authority today; Wall Street. The figures for publicly-held builders have flip-flopped. Today less than 20% of the builders are privately held with the rest publicly-traded. This has a profound effect on the pricing cycle because builders are viewed as a vertically integrated retailer now. Did you ever wonder how these mega developments have the staying power they have now? That staying power is a function of the cost of capital which today, is equity. Equity financing is longer term money and requires no servicing, at least, in the near term.
Equity financing allows home builders to take a longer term view when building out developments. They option large tracts of land 8-10 years before they plan to build . They hedge their bets against radical migration trends. This allows them to secure dirt at a low price, well in advance of the migration to a market. Once committed, they lock up labor and materials with forward contracts. This hedging allows a builder to secure profitable housing developments 3-4 years before ground breaks. Mix in the recent run up in housing prices and you have builders with huge unrealized profits and no carrying costs.
The downside of the pubic markets financing is that stockholders eventually want profits. This means that builders can play with numbers by offering incentives and enhanced Realtor commissions without adjusting prices for a limited time. 3-6 quarters of disappointing profits and static inventories will result in pressure from Wall Street to reduce those inventories through drastic price reductions.
What does this all mean to you, the professional Realtor, when trying to price houses in your local market? It means your listings must be priced 5-10% below local model matches offered by the builder.
New homes typically sell at a 5-10% premium to resales. There are six
resales listed for every one new home in the MLS today. The problem is
that most of those listings are really not serious sellers; they have
an “I‘ll move if you pay me this” attitude. That attitude could be
dangerous if they are serious about transferring equity to a new home.
What about the big price drop coming from the builders? Well, that may or may not happen. Remember that a builder is really considered a retailer today. If inventories gradually drop from the aggressive concessions, a “fire sale” won’t be necessary. I would argue, however, that “fire sale” pricing could actually benefit the resale market as it reduces the most desirable inventory quickly and sets up the next boom. The builders will watch the market demand build and come out with new product at dramatically higher prices than the old inventory. That’s when it’s time for your seller’s to start getting greedy.
PLAN OF ACTION: Tell this story to all of your listings to test their desire to sell the home. Explain that pricing needs to be just below the new builders and ahead of the potential “fire sale” the builders might have. Otherwise, you may just spending marketing money for a seller that has a “I’ll move if you pay me this” attitude. And that, may be detrimental to your health.