Dave Clark

As spring turned to summer, two things were all too clear to builders: Aggressive price discounting in ­distressed markets wasn’t enticing nearly enough buyers to come in off the sidelines; and the lack of detailed, market-by-market information about the only houses that were selling—foreclosures—made it harder to determine where the price floor for new homes needed to be.

The downturn’s aftershocks have forced builders, analysts, and economists to rethink what price and sales data actually reveal about future housing trends. The ­industry’s foundation has been shaken by events that so far resist patterns, and economic conditions are so volatile right now that predictions end in question marks.

Consider the once widely held belief among many large builders that the housing industry could price-cut itself out of recession. After more than a year of ­unprecedented discounts, the evidence, with limited exceptions, is proving otherwise. New-home sales in May—a month that emerged as a bellwether of sorts—fell 40.3 percent from the same month a year earlier to a seasonally adjusted annual rate of 512,000 units. This descent occurred despite a 5.7 percent decline, to $231,000, in the median price of a new home for sale that month, according to Commerce Department estimates. “We predicted, wrongly it turned out, that price reductions on new homes would tip the scale,” and put buyers back in play, says W. Scott Simon, managing director with PIMCO, the Newport Beach, Calif.–based income management firm. “But sales keep going in the wrong direction. It’s almost counterintuitive.”

The new bargains

What, then, has kept existing-home prices from surpassing new homes, especially when many owners still won’t sacrifice equity unless they absolutely must sell? In Phoenix, for example, inventory on multiple listing services has hovered around 57,000 homes for several months. But of that total, “there are maybe 20,000 to 25,000 [homes] that will never sell at the price they are listed for, so they may not actually be for sale,” observes RL Brown, an analyst who publishes a well-read monthly housing report on that market.

But one can find existing homes that are pricier than new homes in Phoenix, as well as Las Vegas, Southern California, and parts of Florida, observes Larry Seay, CFO for Meritage Homes in Scottsdale, Ariz. These are the markets where production builders, burdened by unsold inventories, have brought prices down so low that a comparable resale is no longer the bargain. This phenomenon can also be found occurring in less-distressed places, such as Northeast Utah and Southeast Idaho, where energy-related industries have thrived as oil prices have spiked, producing “humongous” appreciation in existing-home prices, says Trever Einerson, project manager for Timberhawk Homes. Timberhawk specializes in attached townhouses that average 1,400 square feet and sell for around $150,000. By controlling its construction costs, this builder keeps its prices low and expects to sell 200 units this year, ­versus 50 in 2007.

On the other hand, in markets such as Charlotte, N.C., where economic forces aren’t as great a factor, the gap separating new from existing prices has widened over the past year, notes Blair Kendall, a representative for C.P. Morgan Communities. Michael Castleman Sr., chairman and CEO of the research firm Metrostudy, says he’d be “surprised” if comparable existing homes cost more than new houses in most metro markets. Any price advantages builders might enjoy now will be lost unless they continue lowering their prices, which Castleman and several economists believe must happen for builders to reduce their huge inventory overhangs. But some production builders with loads of unsold homes are reaching a point where further price slashing is counterproductive. New-home prices are “pretty close to the bottom,” asserts Seay, because “no one is going to build if you can’t get some cash out of your land and a nominal return.”

Foreclosures change everything

When the S&P/Case-Shiller Index, which tracks existing-home prices in 20 markets, took its steepest dip ever, 15.3 percent, in April, some industry watchers inferred that owners selling houses might be facing reality and lowering prices. The National Association of Realtors lent credence to that belief when it estimated the median price for existing homes fell by 6.3 percent, to $208,600, in May from a year ago. (Sales, though, dropped 15.9 percent to an annualized rate of 4.99 million.)

But the more obvious and overwhelming factor contributing to this trend is the sheer number of foreclosed homes coming back onto the market at significantly reduced prices. “There are incredible changes in the combination of homes being sold today, and one can see a weakness at the lower end of the price scale because of all the foreclosures,” says Jim Diffley, an economist with Global Insight. In Merced, Calif., 95 percent of resales in May were foreclosures, and a buyer could purchase a 1,600-square-foot house for $86,000, versus the high $200s it sold for during the market’s peak.

Greg Paquin, president of the Folsom, Calif.–based market research firm The Gregory Group, says that while new-home buyers in Northern California sit on the fence, “people are buying [foreclosed homes] like crazy.” He adds that virtually all foreclosures are being priced at or below $500,000, which influences how builders market new homes. Paquin told Builder in June that in Sacramento County—where foreclosures contributed to a 30.8 percent sales increase in May, but where new-home sales that month were down 32.8 percent, according to DataQuick Information Systems—JTS Communities advertised “foreclosure prices” at one of its new-home subdivisions.

Smaller markets, more affordable houses

Foreclosures aren’t a negative, says Seay, if they bring market prices back to equilibrium by pushing existing-home prices down. “Foreclosures are changing everything,” adds Russ Valone, president of MarketPointe Realty Advisors, which tracks San Diego’s housing market. “But what I’d like to see is more segmenting of the sales data,” which would provide details, by market or even community, about the composition and physical condition of foreclosed homes, their selling price, and buyer preferences. That statistics rarely tell the full story has long been a complaint by builders and analysts who have little trouble finding contradictions around every local corner. Brown notes that builders and analysts too often use the wrong measuring sticks to predict where home prices might be headed when they compare prices today against “unrealistic and unsustainable” peak values. A more meaningful comparison, in his estimation, would gauge today’s prices against 2003 numbers.

A return to their pasts might be where many builders are headed. San Diego, for example, could come out of the downturn “a very different market,” predicts Donna Morafcik, a spokeswoman for the builders association there. She foresees annual permits, which hit 16,000 in 2002, eventually receding to around 5,000.

Where it competes with foreclosed resales, Orlando, Fla.–based Park Square Homes showcases its affordable Cottage Collection that, in St. Cloud, Fla., starts at $164,900 for a 1,170-square-foot, three-bedroom house. In all of its communities, Park Square adjusted its standing inventory to target buyers in central Florida whose household incomes average $65,000, which means its houses are priced below $225,000. That new tack seems to be guiding this builder to some light at the end of the tunnel, says CEO Suresh Gupta. “We had a pretty good May, and June looks like it would be good, too.”

Learn more about markets featured in this article: Phoenix, AZ, Los Angeles, CA, Charlotte, NC.