Capital

Homebuilding's Biggest Challenge For Q4 2022: Setting The Floor

Price, pace, and product are all in play in the wake of the impacts of inflation, schedule disruptions, and soaring rates. Expect the winners to be first to market with new prices, new products, and new absorption rate momentum.

Capital

Homebuilding's Biggest Challenge For Q4 2022: Setting The Floor

Price, pace, and product are all in play in the wake of the impacts of inflation, schedule disruptions, and soaring rates. Expect the winners to be first to market with new prices, new products, and new absorption rate momentum.

September 22nd, 2022
Homebuilding's Biggest Challenge For Q4 2022: Setting The Floor
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The pricing floor.

For a big national public and a tiny private homebuilder a pricing floor is an essential part of the journey – extremely bumpy, depending on the local market -- through a viability and prosperity stress test that recurs when housing cycles peak and head down.

Who'd-a-thunk it a year ago? Now, the pricing floor – an amalgam of financial calculus and a behavioral economics' construct, Animal Spirits, within which nest buzzwordier expressions like FOMO, YOLO, and more dated terms like "buyer's regret"– preys on all our minds.

A pricing floor is less meaningful for what it exactly is than where it's located and what it does. It behaves – when it works – as an emergency reboot button for a machine that has sputtered and stalled, but which needs to run constantly.

On the bubble of Q4 2022, it's anybody's guess, where that pricing floor is, and whether it'll work as a restart function.

The financial calculus amounts to switches and levers aimed at repricing-in potential buyers. They have been, or are close to being priced-out of the new-home market thanks to the blend of historically-high Average Selling Prices for new homes and monthly payment-crushing new mortgage rates.

The behavioral economics construct works on those who are little-to-not-at-all-affected by price or mortgage rate barriers who may believe that they'll get more value for their money if they wait.

The pricing floor, which is actually a full-stack of business tactics and trade-offs, bundled up like foxhole prayers, is a catch-all for whatever it takes to move new home inventory that has lost its pulling power, by repricing in some and by swaying discretionary buyers to buy now.

Included in the pricing floor are all of the tactical mechanisms and enticements – mortgage rate buy-downs and locked-rates, down payment assistance, free options and upgrades, lot premiums, one-time-buy-now-offers, etc. – that both enable and induce would-be homebuyers to become homebuyers. They span both math and mindset – qualifying more people for their lower priced homes by lowering the prices further, and alluring more people for their higher-priced homes with time-sensitive value offers.

The pricing floor by definition is a time-buying fix, like a tourniquet is a fix.

In most homebuilders' case, stopping the bleeding means getting inventory, first to budge forward, and then keep moving that way. Failing to take that measure means risking either or both of homebuilders' only two alternatives to their home inventory moving forward: Idling or sliding into reverse as a result of cancellations. To any firm without a treasure trove of personal cash at the ready, idling or going into reverse in inventory is a death knell for companies with secured debt.

Added to the challenge of finding a pricing floor is the thickness of homebuilding competitors in most of the nation's most-active new-home real estate and construction markets. In a sense, in such heavily competitive markets, builders don't work in a vacuum. The floor is set as low as the biggest, most invested players in the market deign to set it. Whoever strikes first, fastest, and with the greatest impact on any given market's buyer pool succeeds in taking at least a share of buyers away from other rivals. The ensuing thrash for the remaining marketshare is not pretty and is very expensive for those rivals.

The financial calculus route to a market clearing looks from the outside of most homebuilding firms like a trial-and-error reverse-business-engineering and trade-offs process.

The price floor starts with a guess at what it will take to kick-start pace. It may be a 5% reduction or as much as a 20% reduction. Whatever that level is, the trade-offs and reverse engineering begin with a homebuilder's key opportunity area first, its unit-level gross margin, as a starting place to fund the price cut.

Builders also make a run at their pricing deals with all of their vendors and suppliers, using whatever clout they have to ratchet down present and future input costs for materials, products, installation, etc. They'll look to walk – if they have to – from land deals, take their medicine, put some projects into mothballs, anything to cut carrying costs to where a lowered pricing floor can look and feel like a going concern business.

Part of the pricing floor challenge is the issue of duration. Some businesses who've seriously de-levered and been laser-disciplined in the area of ensuring their current pipeline of projects is positioned as outlying performers in more adverse conditions, and others with extra patient capital may feel a newly lowered pricing floor will be tolerable for as long as the Fed is tightening the spigots on borrowing and stimulus.

That could be a while:

New York Times economics correspondent Jeanna Smialek writes:

Policymakers plan to keep going. Central bankers now expect to lift borrowing costs to 4.6 percent by the end of 2023, their fresh projections showed, up from an estimate of 3.8 percent in June. Fed officials do expect to begin lowering rates in 2024, but they anticipate bringing them down slowly."

Duration – or the time it takes to ... – may have one definition, but everyone who makes a livelihood in the business of investing in, developing, designing, and building homes and communities knows that definition means different things to different players.

Duration, underwater for instance, means an entirely different thing for one who's wearing an oxygen tank versus the one who's holding his or her breath.

It's the same difference for a pricing floor. When the trade-off is gross margins for an organization whose capital structure is public debt and equity, it's like wearing an oxygen tank versus the percentages of gross margins a private homebuilder uses to service their debt and pay off private equity fees and payouts.

Still, midway through September of 2022, most U.S. builders already have to or are about to have to find one: a pricing floor.

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ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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