In a volatile housing market, uncertainty tends to creep into the decisions made within the homebuilding industry. Questions such as, “Is now the right time to deliver lots into the market?” or, “With the current level of home inventory in our competitive trade area, how will this impact my pricing power?” Managing unknowns and uncertainty is an important aspect in most significant decisions. However, indecisiveness in the midst of dramatic market swings can have damaging consequence leading to ignoring apparent and broad market trends.
Understanding and monitoring equilibrium levels for the new-home industry is one way to incorporate broad market trends into your daily decision-making process. Searching for equilibrium is an effort in identifying the balance point of a market, which would indicate that the home building community’s ability to close on new homes (demand forces) is being met by an appropriate level of finished vacant homes (supply forces). Conventional wisdom dictates that with an increase in the supply of finished vacant homes (unoccupied or “spec” homes) a disruption in the equilibrium will occur, leading to downward price adjustments in order to offset this imbalance of supply. Conversely, during an expansionary period for new homes, any excess demand (or shortage of new homes), will lead to price increases, which in time leads to cuts in the quantity demanded as homebuyers are priced out of the market. As such, the housing market has come full circle with this cycle in the past five years. While many markets around the country have experienced some level of increased inventory for finished vacant homes in recent months, there is no cause for concern at this time, and in some cases has been a welcome and healthy change. This increase can be attributed to a variety of factors such as rapid price appreciation, contract cancellations, and increased interest rates.
The result has cast a bright light on the current status of finished vacant inventory and overall housing supply equilibriums. A decline in home closings pushes the month’s supply of finished vacant homes higher. Nationally, equilibrium, or a healthy level of finished vacant homes ranges between 2.5 to 3.5 months, however in some markets the range can be slightly lower or higher depending on construction time and seasonal weather. Based on the current pace of absorption, there is a 2.5 month supply of finished vacant home inventory for both attached and detached for sale product throughout the nation, a level well within equilibrium. However, when the nation was deep in the recession, the supply of finished vacant homes peaked at 5.5 months. Heading into the recession, finished vacant home inventory had started increasing as more and more home buyers cancelled contracts and simply walked away from earnest money. Early in the process, Metrostudy had begun to comment extensively about the change in housing market conditions and builders needed to make calculate the operating adjustments necessary for their individual markets.
Finished vacant inventory has always been a premium leading indicator of prospective market change. Metrostudy often referrers to this metric as the “Canary in the Coal Mine” figure. It is important to monitor finished vacant inventory levels in order to be aware of looming risk. There is an opposite yet equal assessment to be made as it is declining that forecasts opportunity. With tighter lending practices and increased interest from consumers over the past couple years, builders have struggled to put finished vacant homes on the ground. Capital has not been as readily available, which has limited the number of spec homes started by builders. Also with consumers rushing into the housing market in an attempt to get in before interest rates and prices increase more, builders have not had the opportunity to finish homes, and have ultimately sold the home during the construction process. As such, this has resulted in the decreased supply of finished vacant homes. This scenario can highlight significant local opportunities for development with little competition assuming you can conquer the financing hurdles that exist today. But, will this trend continue, and if so, how long?
The simplest way to establish equilibrium is to let the market dictate the appropriate supply of inventory. Understanding the nuances of a market area such as construction time, the will of political officials, availability of land, as well as builder strategies and the level of public builder activity will also help clarify suitable levels of finished homes a market in equilibrium can carry. Contrasting each county, city, or custom submarket’s supply of finished vacant inventory to the overall market equilibrium will further clarify the general health of the new-home market. While equilibrium can change over time depending on the supply and demand characteristics of the market, monitoring and contrasting the supply of finished vacant home inventory for the broad market and specific areas can help reinforce strategic decisions, particularly during uncertain times.
Using Metrostudy’s Builder Insight, our mobile, tablet-based tool, you can quickly get a clear view into the housing situation on the ground in any local area – which builder or project has the most finished vacant homes, and are they within equilibrium levels, if not, why. Also, if you plan to start building in a new project, how will your homes affect the overall supply and price.
Learn about how “Builder Insight” provides you with local market activity trends analyses and get a sample of one of our local market reports is designed here.