Between spec homes that didn't sell, investors who canceled due to market conditions, and move-up home buyers who couldn't sell their existing homes, builders got stuck with a lot of inventory in 2006. Many builders reported cancellation rates as high as 40 percent for the year.
The supply of new homes, which does not include cancellations, increased from a 5.3 months' supply in January 2006 to a 7.2 months' supply during the second and third quarters of the same year. The number of vacant (new and existing) homes on the market rose 34 percent from 1.56 million at the end of 2005 to 2.1 million at the end of 2006, the fastest year-over-year rise ever recorded by the U.S. Census Bureau.
Because investors did not own up to being investors, despite some builders' efforts to weed them out through lengthy questionnaires and background checks, nobody knew how big a market segment they constituted, nor did anyone know how large a problem it would be when they stopped buying so heavily, says Lance Ramella, senior managing director of Hanley Wood Market Intelligence, a sister division of BUILDER. Analysts were estimating investors made up 10 percent to 15 percent of the market, but it was more like 20 percent to 30 percent, Ramella says.
"Not only did they disappear, they flooded the market with all of their units. Everything they bought, they put back on the market," he says.
As a result, there are more than two million vacant homes on the market, one million more than normal, says Margaret Whelan, managing director for home building and building products at UBS.
Due to so many closings turning into cancellations and coming back into the fold as inventory, Pulte Homes reduced its speculative home starts from one-third of all starts to less than 5 percent, says company president and CEO Richard Dugas. The company even has homes sitting at the slab stage, not moving forward until more inventory is sold, he says.
Centex Corp. saw its sales per neighborhood decline significantly, and with the slower sales rate, Centex saw its land supply increase from a two-year supply to a three-year supply. But CEO Tim Eller believes the company will be back to a two-year supply by 2008.
Due to soft prices, Beazer has "mothballed a few communities," CEO Ian McCarthy says. "We think the market will come back in 2008, but we think it's going to be a tough year in 2007."
Just when will the market turn and give builders pricing power again? Toll Brothers CEO Bob Toll and a few other builders see that occurring in late 2007. And in some markets, it may just happen. Washington, D.C., and areas of California were the first to turn bad, and could be the first to rebound, says Beazer's McCarthy.
But other industry players think the market won't turn until 2008, and John Burns, president of John Burns Real Estate Consulting, thinks it's even later.
"Price stability probably won't occur until 2009 or even later," Burns says.