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New-home market 'at a crossroads' amid uptick in canceled contracts, incentives


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Homebuilders across the U.S. are shifting their strategies and financial outlooks amid changing consumer demand for housing.

But where the jury is still out is whether the trend toward elevated canceled contracts, more incentives and lower demand for housing is settling out to pre-pandemic levels — when demand for homes was still higher than historic norms — or will continue to worsen.

The nation's publicly traded homebuilders, in earnings calls reporting their most recent quarter's financial performance, are seeing similar trends and patterns across their portfolios as the housing market shifts amid higher interest rates and fears of a recession. The three-month period that ended in June is the first full quarter that illustrates how the housing market is changing for builders, coming off pandemic highs.

The effects are being felt across the country, although some places are feeling it more dramatically than others. Pricey West Coast markets and metro areas that've far outpaced national norms during the pandemic are seeing the sharpest corrections.

In Phoenix, one of nation's hottest pandemic housing markets, the contract cancellation rate through mid-July was in the 30% range. That's up from 8% to 10% in 2020 and 2021, and up from 15% in 2018 and 2019.

Rick Beckwitt, co-CEO and co-president of Miami-based Lennar Corp. (NYSE: LEN), said during a call with investors in late June its Florida markets were among the better performing in the country through that month. Beckwitt identified seven markets where Lennar has had to lower prices and offer more attractive financing options: Raleigh, North Carolina; Austin, Texas; Minnesota; Seattle; and Los Angeles, Sacramento and the Central Valley in California.

Uptick in canceled contracts, incentives

Most homebuilder executives point to June as the first month where an observable slowdown occurred in the broader housing market.

Nationally, about 60,000 of home-purchase agreements fell through in June, or 14.9% of homes that went under contract that month, according to Seattle-based Redfin Corp. (Nasdaq: RDFN). In June 2021, that share was 11.2%.

Arlington, Texas-based D.R. Horton Inc. (NYSE: DHI), the nation's largest builder, said its cancellation rate in its third quarter ending June 30 hit 24%, compared to 17% the same quarter a year prior. The builder's net sales orders in Q3 decreased 7%, to 16,693 homes, and its total net sales order value increased 8% from the prior year, to $6.9 billion.

Atlanta-based PulteGroup Inc. (NYSE: PHM) saw 1,152 contracts canceled in the second quarter, a rate of 15%, up from 665 cancellations at the same time last year, or a rate of 7%. Net new orders in Q2 declined 23% on an annual basis, to 6,418 homes, and total net sales order volume was $3.9 billion, a decrease of 8% from the same period last year.

Mike Murray, D.R. Horton executive vice president and co-chief operating officer, said during the builder's July 21 earnings call the company has been able to resell cancellations, but that typically takes from four to 12 weeks because of the mortgage process.

Bill Wheat, D.R. Horton executive vice president and chief financial officer, said the cancellation rate in the builder's Q3 was closer to what the company considers normal, as compared to below-normal ranges through much of the pandemic.

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Builder executives say much of what they saw from buyers between early April and late June was a direct response to the Federal Reserve's more aggressive interest-rate hike at its May meeting. A more dramatic escalation in mortgage rates occurred around that time.

But even after the Fed's most recent hike in late July, three-quarters of a percent, many housing economists are predicting mortgage rates will start to stabilize. That could give buyers a greater degree of predictability — although affordability will still be tough for many.

"After a two-year boom market unlike any other in history, the new-home market is at a crossroads," said Eric Lipar, chairman and CEO of The Woodlands, Texas-based LGI Homes Inc., during the company's earnings call Tuesday. "From a short-term perspective, homes are more expensive, consumer prices are up and (the) move (to) curb inflation nearly doubled mortgage rates."

Lipar and others pointed to broader underpinnings — including a strong labor market, demographic trends and tight rental supply — as reasons to remain confident in the new-home market.

Still, as buyers adjust to the new elevated interest-rate environment, builders are upping incentives to keep momentum going.

That includes mechanisms such as mortgage interest rate locks and buydowns to buyers, such as what D.R. Horton has been offering. That builder, which focuses much of its business on the price-conscious first-time buyer, is also beginning to offer other sales incentives as necessary on selected homes and inventory, Wheat said.

"As we adjust to current market conditions, we expect the pace of our sales price increases to slow during the fourth quarter and for our incentive levels to increase from historical lows," he added.

Ryan Marshall, president and CEO of Pulte, said during the builder's July 26 earnings call the majority of incentives in the builder's second quarter took the form of longer-term rate locks or rate buydowns. He said many buyers can still afford the price of a new home but some need a little help.

It seems likely, though, incentives will be in play for the foreseeable future, which will certainly factor into home-price growth and a builder's profit margin.

Enlarge

Lennar Homes is building a new $80 million, 300-home community in west Orange County dubbed Summerlake.

LENNAR HOMES

"Depending upon the community, home-price appreciation has slowed, stopped or, through the use of incentives, is taking a couple of steps back," Marshall said. "Through much of the second quarter, incentives were mostly tied to the mortgage, but this is now expanding to include discounts on options and lot premiums.”

Shifts in strategy, spending

In response to slowing buyer demand, and continued elevated costs, builders are assessing how to manage their pipelines in the coming months as the U.S. economic outlook hangs in limbo.

Greater advertising and marketing spending is one tactic being employed by a couple of builders despite a move toward cost-cutting. Lipar said LGI has increased its advertising spending with favorable results. In July, nearly 20,000 people inquired about moving from renting to homeownership, a 54% increase over last year, he added.

"Now's the time to spend more money on marketing," he said.

Pulte executives say they are looking to increase the company's share of speculative homes, an industry term used to describe a move-in-ready home built on speculation that it'll sell easily for a profit. The company will continue to primarily be a build-to-order builder, Marshall said, but changes in market conditions have it pushing its share of spec homes to 30% or higher.

"We'll be starting specs across the spectrum," said Bob O’Shaughnessy, executive vice president and chief financial officer at Pulte, during the builder's earnings call.

D.R. Horton has made headlines for growing its build-to-rent business, a hot segment of the rental market many for-sale builders have waded into in the past couple of years. D.R. Horton in February was projecting to grow its rental operation this fiscal year by $1 billion.

When asked by an analyst whether some of D.R. Horton's land positions could be converted from for-sale to rental housing because of changing conditions, Murray said demand is evaluated in making those kinds of decisions.

"We always thought build-to-rent is a great way to more rapidly monetize land positions without cannibalizing (our) for-sale business because it's a different user of that real estate and different owner of the real estate," he continued. "We certainly have repurposed projects that we originally may have identified three to four years ago (as) for-sale. Today, they're being executed as for-rent, and that process continues."

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