Housing demand began to fade late last year, and inventories of unsold new homes grew in the process. The shift in the supply and demand has changed the housing market from a red-hot sellers' one to a cooler version in which buyers have more leverage, and the pendulum is not likely to swing back for the rest of 2006.
As a result, builders are adjusting to these changing market conditions. A nationwide survey of nearly 500 single-family home builders conducted by the NAHB in January identified some of the measures that are being taken to support sales and limit cancellations.
Price Adjustments: Most builders prefer not to trim asking prices when demand ebbs, largely because they don't want to upset previous buyers. But our survey picked up some price cutting in response to growing buyer resistance to elevated market prices: Nineteen percent of the respondents said they had reduced prices to maintain sales volume, and the average cut was 5 percent.
Production Mix: Some builders have reacted to growing price resistance by adjusting their production mix. Indeed, 32 percent of the respondents said they were placing more emphasis on lower-priced models and less emphasis on high-priced models in current and planned production.
Realtors/Brokers: One-third of the respondents said they had increased their use of Realtors/brokers in an effort to maintain sales at current prices—a strategy that can bolster sales but doesn't deliver cost advantages to buyers.
Nonprice Sales Incentives: Builders also have cranked up various nonprice sales incentives offered to prospective buyers. In order of importance, the incentives were as follows: including optional items in homes at no cost (41 percent); paying closing costs (31 percent); paying up-front financing points (15 percent); and buying down mortgage interest rates (8 percent). The average value of incentive packages (often including several types) was about 2.5 percent of the sales price.
KNOW THE RULES Builders should realize that the housing finance industry places limits on the amount of seller contributions to a home sales transaction. The primary issue is sales incentives that bolster demand and price without also bolstering the appraised value of the home, which compromises the loan-to-value ratio and threatens the quality of mortgage credit down the line.
Builders offering free upgrades that raise the market value of homes do not run afoul of the housing finance rules. But payments of closing costs and financing points—as well as the value of interest rate buydowns funded by builders or their affiliated mortgage companies—are subject to limits. For loans with down payments of less than 10 percent, the rules generally limit such seller contributions to 3 percent of the sales price. Contributions above the limits must be deducted from sales prices before allowable mortgage amounts are determined.
It is also worth noting that mortgage investors and insurers draw the line against undisclosed seller contributions that are given to buyers outside the loan closing process—such as cars, club memberships, and other giveaways. The entire cost of such things is supposed to be deducted from the sales price when determining allowable mortgage amounts.
Chief Economist, NAHB Washington, D.C.