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| Reversed New Home Premium Likely Understates Extent of Discounting |
| Written by Jonathan Smoke | |
| 11.21.2007 | |
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Discuss this article on the forums. (0 posts) BusinessWeek’s top news story online yesterday was an article by Prashant Gopal about builders discounting and offering incentives so much that in many major markets, buyers are now “paying more for the lived-in look.” Kudos to Prashant for that turn of phrase to describe the reversed new home premium. My boring way of describing this reverse is that while new homes normally sell at a premium to comparable properties, in 2007 that premium has turned into a discount. When comparing the cost of new homes as a price per square foot to existing homes, we are seeing a rapid decline and departure from the norm.  Through data we can now compile from Neighborhood Insights, we have visibility into the price per square foot of new and existing homes for the194 MSAs where square footage data per home sale are readily available. While not all markets are represented, this does include the vast majority of major new home markets. Therefore, the composite of the 194 MSAs is a very good representation of what is going on nationally. We provided this new home and existing home price per square foot data to BusinessWeek, but I prefer to look at it as the chart above. This chart shows the data over a longer trend and as the premium -- or the relative percentage difference -- of new homes over existing homes.  Using the price per square foot to measure the new home premium is better than comparing average home prices as there is normally a disparity in the size of new homes relative to existing homes. What this metric can’t control for is disparity in the locations of new homes versus existing. This means that in many markets with limited land and low affordability such as Los Angeles and San Francisco, we historically see new homes trade at a discount to existing homes because the new homes are in less desirable areas.BusinessWeek created a nice slide show to look at the price per square foot displayed by market and by month for several of the larger markets experiencing this trend. You will notice some markets display big swings in this metric, driven by shifts in locations of homes sold in relatively low volumes when measured on a monthly basis. But even the national composite reveals some pretty wide variation. We think the general trend is clear and happening in most markets and is reflective of the pressures builders have to generate cash flow by moving inventory even if it may generate a short-term loss. As one of our thoughtful readers commented on last week’s Atlanta post, it’s likely that this home premium view is understating the extent of discounting. Many incentives such as paid closings costs and free upgrades do not get factored into the price recorded, and they don’t impact the square footage either. There are markets that are bucking this trend. What those markets generally have in common is that they are not large new home markets and therefore do not have a high number of big builders operating in them. We’ll take a look at a few of them once we are full of turkey and football. 
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