During a teleconference on Wednesday to discuss their company’s quarterly financial performance, Pulte Homes’ officers assured analysts that they were getting the builder’s spec-homes inventory under control. During the quarter, Pulte reduced its specs by 32%, to 2,400. Of that total, 1,300 units were finished specs, down 29% from the same quarter a year ago.

The perennial debate about how much spec inventory is necessary has taken on new relevance as builders have scaled back their construction activities dramatically. The recession is calling the shots now, which is why Guarantee Bank decided to knock down 16 spec homes in Victorville, Calif., it had taken back from a builder in default of its loans. The lender calculated that it would be cheaper to tear them down (about $100,000) than to complete and try to sell them ($1 million).

Specs are still being built, and a slew of builders still advertise ready-to-move-in options on their Web sites. But at a time when there’s 10 months of unsold new homes nationwide, many builders are far more cautious about their exposure with homes that don’t already have committed buyers.

“It never makes sense to build spec homes in a downward market,” wrote one builder in response to a blog posted online this week by BUILDER’s editorial director Boyce Thompson about building specs to exploit the $8,000 federal tax credit, which expires this December. “Once you start discounting your spec product, you have effectively cut off future presales and jeopardize your sold backlog.” Another respondent, who is a consultant, took a broader view of the specs issue. “It is hard to disagree that spec homes often are less profitable. But in these financial conditions, it may also be necessary to reduce land holdings and [add] sales. Even if [the homes] are speculative and do not directly contribute meaningfully to the overall profit, [they] do move the land and help spread overhead.”

If, as Federal Reserve chairman Ben Bernanke stated earlier this week, the housing market is “beginning to stabilize,” many builders in cocoon mode have to be asking themselves whether they have sufficient product on the ground or in their pipelines to meet pent-up buyer demand, especially for those buyers whose circumstances dictate that they must purchase a home now?

It’s clear that some builders believe they’ve let their inventories drop to levels where they’re losing business to resales, foreclosures, and other builders with stuff to sell. Trendmaker Homes’ president Will Holder told the Houston Chronicle recently that the only houses his company has left to sell right now are what he called “problem inventory” that nobody wants. “We’re down to a dozen houses we’re going to make a deal on,” he’s quoted as saying. The Greater Fort Worth Builders Association’s Spring Tour of New Homes this month will feature 73 homes, which is nearly 20 percent fewer than last year’s event and about half the number in 2006. “Builders are not starting spec homes right now,” Barbara Hackett, the tour’s chairwoman, told the Fort Worth Star-Telegram.

In other markets, specs are helping to keep builders afloat. Shea Homes traditionally has not been a spec builder. But like a lot of companies, a percentage of Shea's homes are now specs because of cancellations. The good news is that Shea’s Arizona division has sold 94 specs and 74 new builds this year through the end of April. But Shea is not looking to start more specs as a result. ‘There’s a demand for the inventory home, but we’re encouraged by the demand for new homes, too,” says Buddy Satterfield, the division’s president. He tells BUILDER that other Arizona builders also have been reducing their inventory homes, “which is a good thing.”

During its first quarter, Scottsdale, Ariz.-based Meritage Homes reduced its spec inventory to 550 homes, versus 768 at the end of 2008. That equated to an average of 3.2 completed spec homes per community, which Larry Seay, the builder's CFO, concedes is lower than what Meritage would like it to be. Seay tells BUILDER that a more normal level would be, on average, between four and five specs per community. “The less-expensive the community, the more specs you’re going to have. To compete in today’s resale-foreclosure market, you need to have a certain amount of homes that people can move into quickly,” says Seay, whose company is generating more than half of its business from specs.

Meritage is staying away from a two-tiered pricing system that lowers spec homes to the point where presale prices get undermined. “Specs are no longer the bargains they once were,” Seay says.

In Tampa, Fla., Lennar’s Central Florida division is promoting the availability of ready-to-move-in homes in all 29 of its communities, whose prices start at under $100,000. The division averages between two and three completed spec homes per community, “and the majority of people coming to our neighborhoods are looking for immediate occupancy,” says a Lennar spokesman. Mark Methany, the division’s president, tells BUILDER “because we’re not a design-studio builder, the bulk of our real-estate transactions are specs.” While his division has a fair amount of homes it sells before they are started, “we’re not programmed to wait for that” before initiating construction.

This month, that division is also offering Realtors a $5,000 bonus for homes sold and closed in May. For each successive Lennar home a Realtor sells this month, the builder also will increase his or her co-broker commission a half-percentage point, up to 5% for the fifth house sold. Methany hopes this bonus program will generate between 500 and 750 new-home sales, a portion of which will be spec homes.

John Caulfield is a senior editor at BUILDER magazine.

Learn more about markets featured in this article: Houston, TX, Phoenix, AZ, Orlando, FL.