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| Premiums and Sales Paces Are Real Determinants of Builder Confidence |
| Written by Jonathan Smoke | |
| 10.19.2007 | |
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Discuss this article on the forums. (0 posts) On Tuesday, NAHB and Wells Fargo released their monthly survey results of Builder Confidence. According to their release, builder confidence was further shaken in October due to continuing problems in the mortgage market, substantial inventories of unsold units, and the perceived effect that negative media coverage is having on potential buyers.  The HMI fell two more points to 18 in October, its lowest point since the series began in January of 1985. Given its new lows, perhaps it should be renamed the Builder Funk Index. After all, when the index is below 50, it represents that more than half of builders are depressed about current conditions and near term prospects.So what causes this depression? Ultimately it’s a lack of closings and eroding margins caused by the discounting necessary to move the product that is selling. With the completion of Neighborhood Insights, we now have visibility into new home prices and closings around the country in a way that no one has been able to study before. Bill and I are actively reviewing the new home premium, a new metric we are able to derive by comparing the average price per square foot of new homes versus existing homes. All things being equal, if a new home and its community are designed well and targeted to the right consumer who will properly value every aspect of the product, a new home should carry a premium over an existing home. By using price per square foot, we can control for home size, as size differences between new and existing homes can easily distort any straight price comparisons. While not every market in the country has deep square footage data available, there are almost 200 markets with very strong data, so we’ve been able to construct data for the first time to look at the new home premium overall and market by market. At the composite level, which should be representative of what’s happening nationally, the new home premium has ranged on average between 4% and 12% from January 2004 to mid 2006. Just like home prices, there’s tremendous variance—premiums can be much, much higher in some MSAs and in many submarkets of MSAs. It can also be negative. We can explore causes for negative premiums for new vs. used in more depth at a later time, but a quick reason is reflective of the most important factor influencing the price per square foot—the cost of land. If new homes are in less desirable locations, the location effect can more than offset the new toilet advantage. So what’s happened to the new home premium since mid 2006? It has fallen, and fallen rapidly. As reflected in the closings we have recorded through July, it has even gone negative on average.  Like we saw in Cleveland, builders have discounted so much that they have given away the premium. And it appears that most markets are worse than Cleveland because builders are giving away much more than the premium. So, what does this have to do with the level of builder funk? Most business owners aren’t too confident when market conditions cause them to discount away their prior margins in order to move less than half of what they sold just two years prior. )) Click on image for larger view Will this improve as new home inventories fall to more normal levels? Possibly not. New home premium changes are likely caused by both new home inventories and existing home inventories. While new home inventories are improving, albeit slightly, because of builders' discounting efforts, the declining ownership rate is creating more of a substitution effect from existing homes. Existing home prices are remaining sticky so existing homes are not moving. And the impact on new home sales and prices is bound to be most extreme in markets where there is little historic premium for new homes. Want to track new home prices and closings relative to existing homes in your market? Neighborhood Insights is the only place you can find this incredibly important information along with buyer profiles all the way down to the neighborhood level. 
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