Builders incentives may have done as much harm as good

Mountains of unsold inventory spurred extravagant sales incentives. But customer relations and the perceived value of a house got lost in the shuffle.

By John Caulfield

During an investor conferencein late November, Toll Brothers’ CFO Joel Rassman observed that the proliferation of sales incentives, which builders keep hoping will entice reluctant buyers, was having exactly the opposite effect. “The incremental increase in incentives is chasing customers away,” he asserted. Toll eschews incentives-driven marketing, at least compared to what some competitors are doing, so Rassman’s scold would sound self-serving if it didn’t also reflect sharp divisions among builders about whether incentives have done more harm than good to the housing industry.

With more than 2 million new and existing houses loitering unsold on the market at the conclusion of 2007, incentives aren’t going away anytime soon. There’s been a decided shift away from the mortgage buydowns and option upgrades that were popular in the past, to a greater emphasis on price reductions. D.R. Horton sliced $100,000 from its home prices in selected markets in November, around the same time that Hovnanian Enterprises’ “Red Tag” sale, which ran through Dec. 31, knocked off up to $200,000 from inventoried homes in 10 markets within five Mid-Atlantic states. (Both builders reported swelling cancellation rates in their fourth quarters and jaw-dropping fiscal-year losses.) “Our experience has been that if you price a home right and you make it the right value, people will buy,” says Doug Fenichel, a spokesman for Hovnanian, which hit pay dirt in September when its national “Deal of the Century” promotion generated 2,130 gross sales in three days.

- Incentives are a much broader marketing phenomenon than just a gaggle of giant public builders willingly abandoning profit to sell houses. In Chicago—where only a handful of big builders operate—the Daily Herald reported recently that KLM Builders, a semi-custom builder with $30 million in annual sales, was offering a rent-to-buy plan for three of its unsold townhouses in Antioch, Ill., with half of the rent going toward a down payment. “Incentives are a big lemming,” notes Frank Spadea, who owns Franciscus Homes in Virginia Beach, Va., where builders last year cut prices by as much as $50,000. “Once a few builders started using them, everyone else started chasing them.” Franciscus finally succumbed, too, and paid a buyer’s closing costs, which lowered the price of a house by $8,000 on average.

- The market is more of a free-for-all than ever now that homeowners are in the fray. CNN Money reported on a Seattle-area homeowner who offered two roundtrip tickets to anywhere in the world and six nights in a Four Seasons hotel to anyone willing to buy his house. The Marin Independent Journal wrote about a couple in San Rafael, Calif., who threw in a Prius with the sale. Most owners, though, have adamantly resisted dropping their selling price, despite the market downturn. “The [resale] seller hasn’t faced reality yet,” says Jay Moss, CEO of Mosaic Homes in San Diego. Jack Zausa, president of Zausa Homes in Orland Park, Ill., attributes their stubbornness to what he calls the “party syndrome,” where homeowners don’t want to have to admit to friends that they made a mistake on what they paid for their houses, so they won’t lower their selling prices.

Builders with significant inventory overhangs don’t have that luxury, and recent discounts help accentuate the relative affordability of new, versus existing, homes. Their incentives can still go off “like a hand grenade” and spur reluctant buyers into action, concedes Larry Webb, CEO of John Laing Homes. But he and other builders say this kind of marketing can look desperate to buyers who are waiting for a better deal. “Discounts aren’t relationships; they’re Wal-Mart,” says Webb. And if discounting persists, how effective will it be at driving business? “Lowering price doesn’t in and of itself give consumers a reason to buy homes,” said Allan Merrill, Beazer Homes’ CFO, during Bank of America’s investor conference in December. “We don’t want to be relegated to price being the beginning and end of the value proposition.” Steven Alloy, president of Reston, Va.–based Stanley Martin Cos., says that incentives had already lost steam in his markets by early November. And Chicago-based Belgravia Group uses the fact that it increased prices in 2007 to persuade buyers that the value of their purchases wouldn’t be undermined by future incentives, says the company’s CEO Alan Lev.

- Those builders slashing prices could argue in their defense, “What choice do we have?” Yet, other builders continue to travel alternative marketing routes. Last spring, T.W. Lewis, a high-end builder in Scottsdale, Ariz., launched its “Trade Up to Luxury” program, where it would purchase homes of qualified buyers struggling to sell theirs. NVR’s Ryan Homes has a similar program in place through an alliance with Realtor Century 21. And the Daily Herald reported that custom builder Glanville-Koshul Homes, which in December had four houses on the market in Wheaton and Glen Ellyn, Ill., priced above $1 million, offered to purchase a prospective buyer’s house if it were priced under $700,000. “Right now, buzz is important,” says Tracy Lucas, T.W. Lewis’ marketing manager. “You have to give consumers something other than price to think about.”

- One program Lucas admired was Cachet Homes’ “Buy a Home, Get a Lexus” promotion, which offered buyers $14,400 off the price of a house or a two-year lease on a Lexus, an equivalent value. Cachet, which is also based in Scottsdale, ran that promotion between Oct. 13–21, and over the following 30 days sold more homes than it did in any month during the previous year, says its vice president of marketing Diane Byrne. She believes that the benefits were twofold: In addition to the sales bump, Cachet burnished its brand by collaborating with local Lexus dealers. Branding is important as well to Vistancia, a master planned community in Peoria, Ariz., which conducted a Home and Garden Festival last fall. All eight builders in that master plan, including Cachet, participated in the event, which drew 1,200 people to their 38 models over two days, compared with 100 people per day on average during the prior month. “We haven’t seen that level of traffic since February 2005,” says Sandy Esmey, Vistancia’s marketing director.— J.C .

Learn more about markets featured in this article: Chicago, IL, Phoenix, AZ, Virginia Beach, VA, Peoria, IL.