As New Home Sales Stall, Deals Abound

Desperate builders are sweetening deals on new homes in many of the biggest markets in the U.S.

by Prashant Gopal

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On Nov. 20, the residential real estate industry seemed to finally get an unexpected dose of much-needed good news. After four consecutive months of declines, the number of new homes being built crept up by a stronger-than-expected 3% in October, according to the Commerce Dept.

But on closer look, the October numbers may just be an aberration. Building permits, an indicator of future construction, plunged 6.6% as homebuilders faced mounting inventories of unsold homes and sluggish demand from buyers.

The annual rate for houses and apartments rose to just over 1.2 million in October. But the rate for single-family homes dropped 7.4% to 884,000—the lowest level since the early 1990s. Overall, the pace of groundbreaking dropped 16.4% from October, 2006. The small increase in overall housing starts in October was driven by multi-family dwelling starts, which tend to fluctuate widely from month to month.

A Lack of Confidence

"I don't think there's any good news in the numbers," said Celia Chen, Director of Housing Economics at Moody's Economy.com. "The builders are still pretty pessimistic."

Builders' confidence sank this year as contract cancellations grew and banks tightened requirements for home loans. The National Association of Home Builders/Wells Fargo Housing Market index, which measures builder confidence, held steady in October and November at 19, a record low. The index was on the rise in late 2006 and early 2007, reaching 39 in February. Readings below 50 mean more builders see market conditions as poor than favorable.

Chen said she expects the drop in housing construction to wipe away 1% of gross domestic product growth this year and next, but there might be some good news for buyers. Builders are not just scaling back new home production, they're slashing prices. The new home discounts are so great in many parts of the country that existing home prices can look unrealistic by comparison. Moreover, in many parts of the country new home sales have actually fallen below existing home sales.

Paying More for the Lived-In Look

Until recently many buyers were willing to pay a premium for owning a new home where the bathrooms, kitchen, and bedrooms have never been used. But that premium is vanishing and is even reversing in favor of existing homes in parts of Florida, Las Vegas, California and other over-built areas throughout the nation.

That has pressured many builders such as Ryland (RYL), Meritage Homes (MTH), D.R. Horton (DHI), and others, to make deals. In some cases, builders have trimmed prices to such an extent in the second half of 2007 that buyers in many markets are actually paying less per square foot on average for new homes than used homes, according to data from HousingIntelligence.com, a Web site operated by housing research and advisory firm BlueSmoke.

New homes tend to be larger and include more bathrooms, sunrooms, and other amenities, as well as new roofing, wiring, and plumbing. They constitute a small fraction of the housing market. Existing homes make up the bulk of the market and their prices, on a square foot basis, were dropping at a slower pace even as demand for housing was drying up and concerns deepening over foreclosures and defaults by subprime mortgage borrowers.