After a two-year period where it was not possible to build homes fast enough to keep up with demand, rising interest rates and ongoing affordability concerns have begun to temper demand in the housing market. Zonda’s most recent New Home Pending Sales Index indicated new-home contract sales in June were back to 2019 levels, with some markets, including Phoenix, Salt Lake City, and Las Vegas, performing below 2019 sales levels. Additionally, the supply of new homes relative to sales in June was the highest since 2010. While 2019 was a strong year for housing overall, the shift from the highs of 2020 and 2021 are impacting overall builder sentiment and strategies required to navigate the new market.
“For the second quarter of 2022, the pace of new-home orders was consistent with our company’s historic pre-pandemic order performance for a second quarter, but we did experience a noticeable decline in order activity as the quarter progressed,” says Doug Bauer, CEO of Tri Pointe Homes. The pace of orders per community decreased from 4.7 in April to 2.8 in June. “While we typically see a seasonal slowdown in demand as we approach the summer months, it’s clear the combination of higher rates and lower consumer confidence resulted in a slower buying pace in most of our markets. With the uncertainty around the economy, we believe it may take some time for consumers and the market to find their footing again, although we saw consumer engagement improve as July progressed.”
Changing Market Dynamics
Douglas Yearley, CEO and chairman of Toll Brothers, says while demand is still solid, it has moderated from “the unprecedented pace of the past two years,” with rising home prices, inflation concerns, stock market volatility, and interest rates all negatively impacting buyer sentiment. Mike Forsum, chief operating officer for Landsea Homes, says interest rates and lower consumer confidence “have created a more competitive home buying sales environment.”
In response to qualification issues stemming from rising rates and affordability concerns, many builders, including D.R. Horton and Lennar, sold homes later in the construction cycle to help buyers lock in loans closer to closing. According to D.R. Horton executive vice president and co-chief operating officer Paul Romanowski, “almost no sales” occurred prior to the start of home construction during the second quarter.
“While most of our buyers can qualify at higher rates, we do recognize the emotional element of the equation will likely take some time to reset. As the market continues to search for its new equilibrium, we have seen continued pressure on sales activity, as well as an expected increase in cancellations,” says Sheryl Palmer, chairman and CEO of Taylor Morrison.
Numerous leading builders, including D.R. Horton, Lennar, Century Communities, and DRB Group, also reported slowing the number of starts to better position inventory to align with current market conditions and reduced demand. Overall, privately owned housing starts decreased 9.6% in July compared with June and decreased 8.1% compared with July 2021. Single-family starts decreased 10.1% month over month in July.
“We’re being cautious about starting homes unnecessarily more so than restraining sales,” says Char Kurihara, corporate vice president of sales, marketing, and branding for DRB Group.
The changing dynamics of market demand are causing builders to shift sales approaches. While over the past two years, the emphasis has been on availability of homes and inventory, demand shifts are causing builders to place greater significance on the value of their product, according to Kelly Nguyen, vice president of sales for California-based City Ventures. Carola Cherief, vice president of sales and marketing for Trumark Homes, says the company is focused on “educating” its sales team to build confidence among prospects.
“We’re continuing to understand our customers’ new and changing needs. In evolving markets, it’s less about managing the volume and more about personal service,” says Caitlyn Lai-Valenti, vice president of sales and marketing in Southern California for Brookfield Residential Properties. “This includes guiding customers through the home buying journey with multiple planned 'meaningful moments' encounters.”
Bauer says it is important to ensure that the buyers Tri Pointe has in backlog “feel confident about their purchases and will close on their homes.”
Consumer confidence is being negatively impacted by headlines suggesting housing bubbles and outlining the impending housing recession. The role of salespeople, according to Kurihara, is to be aware of the headlines, general consumer sentiment, and third-party research on market conditions to help dispel consumer fears when possible and restore confidence in buying decisions.
“People are still coming through the door. When they do, they just really want somebody to say, ‘You’re not making a mistake, you are doing the right thing, and here’s why,’” says Kurihara. “You have to be educated about the economics and the predictors and let people know. We’re really trying to educate our sales force to help with consumers. Because when they do come through the door, there’s a reason they did come.”
Cancellation Rates and Incentives
A consequence of the current economic situation of high interest rates and low consumer confidence is an increase in cancellation rates for builders. For Tri Pointe Homes, the cancellation rate rose to 15.6% of gross orders in the second quarter of 2022; D.R. Horton reported a third quarter cancellation rate of 24% compared with 17% in the third quarter of 2021; Lennar reported cancellation rates increased to 11.8% in the most recent fiscal quarter; Beazer Homes experienced a 6.1% year-over-year increase in cancellations in the fiscal quarter; PulteGroup experienced an 8% year-over-year increase in cancellations in the company’s fiscal second quarter; and Landsea Homes reported a cancellation rate of 15% in the second quarter. However, many builders say even with the increase of cancellations, rates are below long-term historical averages.
“Most of [our cancellations] were from buyers who had purchased their home in the last 30 days,” Forsum says. “With the recent improvement in mortgage rates, we are confident some of these buyers will come back to the table.”
A majority of cancellations during recent months can be attributed to qualification issues related to rising interest rates, affordability concerns, and declining consumer confidence. Builders with mortgage affiliates, including Tri Pointe, Landsea Homes, D.R. Horton, and Taylor Morrison, are working to provide incentives such as rate buy-downs and rate locks to help buyers with mortgage rate concerns close on homes. Kurihara says closing costs with preferred lenders have been a top incentive to improve sales volume, but DRB Group has also been adding more cost-effective floor plans in communities when possible as well.
“In our Inland Empire markets where affordability is key and interest rates are above 5%, strategic rate buy-downs help families ease into their new payment, while still securing a fixed mortgage,” Lai-Valenti says. “It’s a flexible program for a fluid situation. Rates have seen significant movement.”
During Zonda’s most recent National Housing Outlook Webinar, senior managing principal Tim Sullivan said a majority of builders reported cautiously moving forward with land acquisition because of a pipeline with a “significant number” of units. Around 20% of respondents to Zonda’s July division president survey reported pausing land deals, while only 5% reported land acquisitions were moving “full steam ahead.”
“Caution is always important, but it is possible to be ‘over-cautious.’ That could mean responding to negative news by dropping all deals in diligence and waiting for the market to level out,” Lai-Valenti says. “[Vigilance] assumes an in-depth look at the current market and assumes a longer play up to 36 months from now. If market shifts have taught us anything, it’s that more shifts can happen, so prepare for the long term.”
Forsum says Landsea has maintained the company’s “risk-averse, land-light strategy,” which emphasizes optionality and capital efficiency to improve returns while limiting exposure “to market risk during periods of uncertainty.” For Tri Pointe, Bauer says the builder has adjusted hurdle rates higher for new land deals to reflect uncertainty and on deals yet to be closed; the company is “stress-testing project assumptions and reevaluating where appropriate.”
Nguyen and Cherief say City Ventures and Trumark, respectively, have remained “deliberate” in their respective acquisition approaches. Kurihara says DRB Group is staying vigilant in its vetting process and remaining opportunistic, but it is not backing off in its approach to purchasing land.
While the trend of housing metrics suggests the nation is in a housing recession, many builders believe that a market normalization—returning to pre-pandemic levels of sales—will result in positive developments for the industry long term. Existing market dynamics, such as the current housing shortage and the strength of the jobs market, are positive headwinds for the housing industry beyond the likely short-term correction.
“Higher mortgage rates and lower consumer confidence may put a damper on our sales efforts in the short term, but we believe the long-term outlook for our industry remains favorable given the undersupplied nature of our markets, disciplined mortgage underwriting standards, low existing unemployment rates, household formation growth, and the favorable demographics that support the need for new housing,” Bauer says.