The Housing Fire Sale

Homebuilders are slashing prices to clear out inventory, according to a new Census Bureau report—and it's working

by Peter Coy

Rule of thumb: If you want to know how bad a housing downturn is, look at prices of new homes. Builders need to keep their cash flowing to meet obligations to lenders, so they do whatever it takes to move the merchandise, even when demand is slumping.

By that measure, things are bad. In a clear sign of builders' urgency, the median price of a new home plummeted by close to 10% in September in the biggest one-year drop since 1970—the year the Beatles released Let It Be and Monday Night Football first aired on ABC.

Not only did the median price fall 9.7% from a year earlier, but it was down 9.3% just from August, 2006, one month earlier, according to the Census Bureau on Oct. 26. The median price fell to $217,100. (Click here to read the Census press release.)

Extra Incentives

Fortunately for hard-hit builders like D.R. Horton (DHI), Lennar (LEN), Pulte Homes (PHM), and KB Home (KBH), the price cuts did have their intended effect: People bought. Seasonally adjusted sales of new houses rose 5.3% in September from the previous month, the Census Bureau said. The sales uptick helped reduce the overhang of unsold homes. At the current rate of sales, there were 6.4 months' worth of unsold new homes in September, down from a recent high of 7.2 months' worth in July.

People in expensive regions of the country, like California and the East Coast, may be amazed to read that the median price of a new home in the U.S. is only $200,000 and change. (By definition, half of all houses sold cost more than the median and half cost less.)

But what's even more amazing is that the Census Bureau's figures may actually understate the extent of the price cuts. Builders have been throwing in extra goodies like granite countertops for free, so the effective decline is even greater than the stated one.

Stock Slump

What's more, the Census figures don't reflect cancellations, which can be a major problem for builders. Global Insight, a Lexington (Mass.) economic-research firm, says in a note that if cancellations were counted, sales would be lower and the inventory higher than currently estimated. Global Insight says cancellations for Lennar and D.R. Horton "are now running at 30% or about twice the normal rate."

Homebuilder stocks were little changed after the Census report. After hitting bottom in June and July, the stocks rose strongly as investors thought they saw light at the end of the tunnel, but they've languished in recent weeks. They're now up about 20% off their summer lows.

The reason new-home prices are a better gauge than existing-home prices is that owners of existing homes can pull their homes off the market when conditions are weak. Doing so shrinks the supply and props up the prices of those few homes that do get sold. Still, even the existing-home market is weak. On Oct. 25, figures from the National Association of Realtors showed that prices of existing homes had fallen for two months in a row. That's the first time that has happened since 1990.

Coy is BusinessWeek's Economics Editor.