IN MY JUNE COLUMN (“INVENTORY OVERLOAD,” page 76), I talked about serious deterioration of the supply-demand balance in housing markets—owing to a large runup in vacant housing inventory combined with renewed downward pressure on home buyer demand due to subprime-related tightening of mortgage lending standards.
This difficult market situation has compelled builders to make severe cutbacks in new production as well as intensify efforts to sell inventory and hold down sales cancellations. These challenging market pressures most likely will persist during the second half of this year and perhaps into 2008 as well.
THE RELUCTANT HOME BUYER The subprime-related tightening of mortgage lending standards certainly has pushed large numbers of prospective home buyers back to the sidelines, and the timing of their return to the market is highly uncertain. There's also been widespread reluctance among consumers who have good access to credit to go ahead with home purchases at a time when affordability remains well below conditions prevailing prior to the 2004–2005 housing boom, when there are a lot of new and existing homes to pick from, and when home prices are weakening in many areas.
Consumer perceptions of the direction of home prices are central to the difficult market conditions now encountered by builders. Projections of rising house prices strengthened demand during the 2004–2005 boom, even as rising prices were taking a toll on current affordability conditions; and projections of falling house prices now are weakening demand even as lower prices are supporting current affordability conditions. Most builders have never had to deal with such a maddening reality before, and the frustration level is mounting rapidly!
WHAT'S WORKING? In May, the NAHB conducted a nationwide survey of single-family builders to track the kinds of incentives being offered to bolster sales and limit cancellations, and we also got builders' assessments of the degree of success being achieved. On the home price front, we found that 52 percent of builders had reduced prices during the previous month. For those cutting prices, the average reduction was 7 percent, similar to the magnitudes revealed by a series of surveys conducted by the NAHB since mid-2006. Nearly three-fourths of the builders who had reduced the prices of their homes said the price cuts were at least somewhat effective in bolstering sales and/or limiting cancellations, but the rest said the cuts were not effective at all.
Nearly three-fourths of builders in our May survey were offering non-price sales incentives of various types, sometimes in combination with price cuts. The most frequently offered incentives stacked up as follows: include optional items in homes at no cost; pay closing costs for buyers; absorb up-front mortgage finance points; buy down mortgage interest rates; and help buyers sell existing homes or offer trade-in programs. High proportions of builders rated all of these incentives as at least somewhat effective in bolstering sales and/or limiting cancellations.
A small percentage of builders said they had offered to match price reductions on future sales of the same models. Despite the apparent appeal of this sales incentive in the current market environment, only about half the builders making such an offer said it was an effective measure.
BOTTOM LINES The supply-demand imbalance in housing markets will persist for some time, and we can't count on surging economic conditions or falling interest rates to bring this housing downswing to a decisive end—unlike earlier contractions that were part-and-parcel of outright economic recessions. In this situation, builders must hold down new production for some time and pull out the stops on both price and nonprice sales incentives. Stay tuned!
CHIEF ECONOMIST, NAHB WASHINGTON, D.C.