Home buyers signed 0.5% more sales contracts on existing homes in December compared to November.
Courtesy Adobe Stock

During the past two years, frenzied demand—driven by low interest rates and pandemic-induced lifestyle changes, among other factors—meant incentives were close to nonexistent in the housing market. Heightened demand, combined with supply chain constraints and a lack of housing supply, accelerated home price appreciation. However, with low interest rates, many home buyers were undeterred, and sales growth remained strong throughout the pandemic.

Today, as rising interest rates have increased amid ongoing home price appreciation, some consumers are becoming both less willing and less able to purchase homes in the current environment, according to Zonda chief economist Ali Wolf. As a result, many builders are increasing their incentive offerings to prospective homeowners to mitigate market hesitation.

“Many builders are finding themselves in a place where they need to sweeten the deal for the buyer,” says Wolf. “We expect if interest rates stay where they are, incentives will become a regular part of the market for a while.”

Zonda data collected in May indicates that nearly 50% of home builders increased incentive offerings on a month-over-month basis. The number is a significant increase from April, when 16% of builders reported they increased incentive offerings on a month-over-month basis.

Nearly 50% of the projects tracked by Zonda have some type of “to-be-built incentive,” totaling an average of just over $7,000, or 0.9% of average list price. Wolf forecasts that if housing demand continues to soften throughout the summer, then incentives will become even more present in the market.

While incentives were seldom used in early 2022 because spring selling demand exceeded homes on the market, they began to tick up during April in response to rising interest rates. According to Freddie Mac, 30-year fixed mortgage rates increased 210 basis points on a year-over-year basis to 5.09% during the first week of June.

“Incentives offer solutions for attracting buyers without reducing top-line prices,” Wolf says. “Incentives are returning to the market in response to the historic housing affordability crunch and faltering consumer confidence.”

She says the most common incentive currently on the market is closing costs with preferred lenders. The second most common incentive is funds toward options and upgrades. Nationally, the average option and upgrade cost is nearly $11,000, or about 1.6% of the list price.

While option and upgrade incentives have typically been offered in the past, they are less prevalent in the current market because of shifting market trends, according to Wolf. Many builders are building spec homes with options and upgrades that have been included in incentive packages already chosen before homes are brought to the market. In several major metro markets tracked by Zonda, option and upgrade incentives were not offered.

During a Zonda housing market update in April, Wolf said several cohorts of buyers, including cash buyers and wealth buyers, are not as sensitive to home price appreciation and monthly mortgage payment increases and have not experienced a decrease in demand. Conversely, the share of entry-level buyers on a year- over-year basis declined in April as many buyers in the cohort found the market “difficult to navigate,” according to Wolf. Entry-level buyers were most likely to be deterred by choice— because of a fear of buying at the top of the housing market—or by force due to affordability concerns because of the rapidly changing landscape for monthly mortgage payments.

Regional Incentive Trends

According to Zonda data, tracking incentives in terms of dollar amount and category, the use of incentives varies greatly across the country depending on markets.

Dallas (8%); Sarasota, Florida (4%); Washington, D.C. (4%); Fort Myers, Florida (4%); and Orlando, Florida (4%), were the major markets analyzed by Zonda with the highest percentage of projects with closing cost incentives in May. Several metros—including Atlanta, Denver, Indianapolis, Las Vegas, New York, and Seattle—recorded no projects with closing cost incentives.

Las Vegas (66%), Indianapolis (51%), and Florida’s Orlando (57%), Fort Myers (54%), Tampa (52%), and Jacksonville (52%) recorded the highest percentage of projects with closing costs with preferred lenders in May. Seattle (20%), Denver (17%), and New York (10%) recorded the lowest percentage of projects with closing costs with preferred lenders of the major metros analyzed by Zonda.

Denver (73%), Sarasota (11%), and Tampa (9%) recorded the highest percentage of projects with option and upgrade incentives in May, while Seattle and Las Vegas recorded no projects with those incentives.

New York (10%), Raleigh, North Carolina (9%), Atlanta (9%), Washington, D.C. (9%), and Fort Myers (9%) reported the highest percentage of projects with other incentives, including broker co-ops, in May.

Cancellations and Incentives

During April’s housing market update, Wolf shared that the number of builders reporting contract cancellations in the market was rising. As of April 2022, 35% of builders surveyed by Zonda said project cancellations were increasing. However, even with demand cooling off, in most cases there has been a buyer waiting to purchase homes with canceled contracts.

“There’s still enough people that want to purchase a home that most times those canceled homes get purchased, but it is showing an inflexion point,” Wolf said during the webinar. “The idea that we didn’t have many cancellations as a share of the overall market [recently], and [while] it’s still not a high percent, we’re having some people on the margins, by choice or by force, deciding to step aside.”

Wolf says if housing demand continues to slow and contract cancellations continue to increase, builders will be more likely to use incentives “than if demand was going gangbusters and cancellations weren’t happening.”

"Incentives can be used as a cancellation buffer depending on why the buyer is canceling,” Wolf says. “More commonly, though, incentives are used as a tool the sales agent can use to get uncertain buyers over the fence.”