Are builders discounting their prices, or are they just selling out to institutional buyers? In this episode of The Great Escape, I’m going to explain why home builders are concerned about the 2023 housing market. We’ll find out whether builders are discounting their prices and what that means for the market going forward.
Canceling Contracts
As buyers are canceling contracts, builders are offering incentives and selling to institutional buyers. Additionally, as higher interest rates scare buyers away and cause them to cancel their current contracts, builders are concerned about what 2023 looks like for the housing market.
According to CNBC, housing stocks dropped 19% year over year. Homebuilders say that 2023 is going to bring in an even sharper downturn in the market, as higher interest rates scare homebuyers away. Cancellations jumped from 15 to 24%, while Zonda Research recorded a 70% new home build cancellation in the Phoenix area.
Builders are concerned that there’s going to be a steeper downturn as buyers pull back. Six months ago, construction was up 10% annually. Now, there’s a historic downturn to a 19% drop in activity. According to the National Association of Homebuilders, this year will be the first year since 2011 to see a decline in single-family starts. With starts below pre-pandemic levels, what’s happening moving forward?
Adding Incentives
Taylor Morrison’s CEO stated that they are pulling back on their land investments. They’re slowing the construction starts and offering buyers additional incentives. Additionally, according to Forbes, their share of new homes on the market last quarter jumped to a 22-year high.
Redfin states that it is forcing builders to sell with steep incentives. Research firm Pantheon predicts that monthly sales will be at a 10-year low of 350,000 units as early as this month. Why is this happening so quickly?
Per Freddie Mac, the mortgage rate was 3.1% last December. This means that a monthly payment on a mortgage of $250,000 was $1,014 per month. At 6.33% interest, that comes out to $1,475 a month, which is a 45% increase.
The Phoenix Market
John Burns data for October shows an overall 45% cancellation of contracts in the Southwest. As I mentioned earlier, Zonda recorded a 70% new home build cancellation for the Phoenix area. So what is this doing to the market, and how are the home builders handling it?
Not surprisingly, one of the top lenders here in the Phoenix area—LoanDepot—has announced thousands of job cuts. Additionally, Wells Fargo is looking at cutting 2,000 jobs as mortgage volume plummets by 90%. Home builders are handling this in two ways.
Buydowns
The first is incentives, buydowns, and price cuts. According to Businessinsider.com, Phoenix-based builder Taylor Morrison is offering a 2-1 buydown. This allows mortgage rates to decrease by 2% in the first year and 1% in the second year—before returning to the fixed rate for the remaining duration of the loan.
Typically after two years, the interest rates would have dropped, allowing you to refinance. This incentive is extended to both conventional and FHA buyers with a 680 or higher credit score. For example, on a $450,000 loan, builders are paying $22,500 to $27,000 to reduce the payment for the first two years.
Institutional Buyers
The second way that builders are handling it is to sell to institutional buyers. According to Marketwatch.com, the build-for-rent market will be increasing supply due to the sale to institutional buyers. This means that there is going to be less supply for buyers, which is really concerning during a time when we’ve continued to see a lack of supply for buyers.
According to The Wall Street Journal, home builders are stuck with more houses than they can sell. Per Bruce McNeilage—the co-founder of Kinloch Partners, a rental home investment company—he receives as many as 10 calls per week from builders eager to sell their homes in bulk to reduce inventory. They’re offering up to 20% discount, though most are usually getting about a 10 to 15% bulk discount.
Moving Forward
What does this mean for builders and supply moving forward? This is going to reduce the homes for sale supply and increase the rental supply. The last few years of supply chain and labor shortages have been really challenging for builders to keep up with the demand, resulting in waiting lists and drawings. This has all ended for now.
However, Barclays just upgraded Lennar. It states that homebuilders can rally more than 25% as the housing market trough in 2023. So who’s right? Time will tell. What do you think 2023 will look like? If you have any questions about the market or moving, please feel free to reach out and I’d be happy to hear from you.
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