Leadership

Is This Time Different? Builders' Playbooks Look For The Same Gains, With Different Plays

Builders downturn strategies typically call for narrowing the pricing gap that gives existing home sellers an edge when demand is low. It's the same now, only different.

Leadership

Is This Time Different? Builders' Playbooks Look For The Same Gains, With Different Plays

Builders downturn strategies typically call for narrowing the pricing gap that gives existing home sellers an edge when demand is low. It's the same now, only different.

March 8th, 2023
Is This Time Different? Builders' Playbooks Look For The Same Gains, With Different Plays
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A plot line typical of housing market down cycles past involved new-homebuilders' clout on the price front. They'd offer new home products during a downturn that narrowed and in some ways eliminated the purchase price gap between their new homes and most of the resale homes available in the market.

Value engineering, process improvement, operational excellence that accelerated velocity – with a big helping hand from vendors on the materials, products, labor, lending, and land front with skin in the game – all added up to erode that gap between new and existing.

This this time's different, but it's also the same.

The difference is the glaring absence – for all intents and purposes – of available for sale existing home inventory with which to close that price gap and gain an upper hand in perceived value.

This amounts to a plus and a minus. The plus is that new homes are The Game in Town. The minus is that new homes don't have the price-focused compare-and-contrast context of greater value to help them spur buyers off the sidelines.

Still, this is where the plot line remains essentially the same.

After all, in a market so volatile, a most-attractive advantage of an existing home – leaving out, for a moment, a lower asking price – is that it offers a buyer a time shield from that volatility. In other words, a buyer can in many cases go from an accepted offer to a mortgage to a closing within a 30 to 45 day period.

This timeframe buffers to some extent the impact of mortgage interest rate changes expected to keep running at an elevated, if not higher, level.

Cue, now, the typical plot line for new home builders, which is – at its essence – a plan to overcome the competitive advantage existing home sellers enjoy when demand levels have decreased and seem to be seeking a floor.

  • Competitive advantage No. 1 – the ability to close in 30 to 45 days.
  • Competitive advantage No. 2 – a price differential between used and new.

With a big dollop of psychological assistance from the easing of 30-year-fixed mortgage rates in late November, December,  January, and into early February, new homebuilders – not having a whole lot of existing home inventory to compete with – homebuilders stepped up to the competitive challenge on both fronts.

Ready-to-own – spec – homes eliminated the first advantage. The ability to buy down a mortgage rate erased a lot of the edge on the second front, at least on a monthly payments basis.

Put those factors into the mix of a new home's approaches to livability, comfort, hybrid lifestyles, space needs, etc.

Bloomberg's Conor Sen writes:

Builders can also get creative with incentives and floor plans to help buyers with affordability, whether that’s cutting prices, building smaller homes or offering to buy down mortgage rates for a period of time to provide some relief on the rates front.
That means there is at least the potential of 2023 being a year where overall housing demand is down because mortgage rates stick closer to 7% than 6%, while the much-smaller new home market actually grows as builders provide more options for people who are able and willing — or maybe forced by circumstances — to move ahead with buying a home.

These tactics come through clearly in remarks from the strategic executive team at Landsea Homes, as they talked through Q4 and full-year 2022 results and a first-blush outlook on 2023 challenges yesterday with investment research analysts.

Below, we're going to excerpt from the transcript of remarks from Landsea Homes CEO John Ho, and from Mike Forsum, President and COO, to spotlight specifically how one homebuilder has availed of tactics to exploit both what's different and the same versus past downturns.

2023 Strategic Themes: Discipline

John Ho, CEO

We have placed an increased emphasis on cost reduction, balance sheet strength and cash flow generation. In terms of cost reductions, we are proactively negotiating with our suppliers, vendors and contractors to make sure that the prices we are paying reflect the new market realities.
"We're also working on establishing more favorable vendor agreements with our national suppliers that factor in our increased size and scale. While land prices typically take longer to adjust during a market correction, we remain disciplined with our land acquisition efforts and have walked away from several current transactions and are prepared to walk away from option agreements should they no longer meet our hurdle rates.
"We have also made changes to our overhead cost structure, reducing headcount by approximately 8%, which would improve our operational efficiency and expense leverage. As we announced earlier this week, we are relocating our corporate headquarters to Dallas, Texas, from Southern California, a move that should provide cost savings over time that will allow us to operate more effectively as a national homebuilder.
"Our current plan calls for a reduction in land acquisition and development relative to 2022, which would put us in a great position to generate cash from operations, giving us additional optionality to pay down debt, reinvest in our operations should more favorable opportunities arise or return capital to shareholders."

Solving For Monthly Payment Challenges

Mike Forsum, President and COO

Following fourth quarter's net absorption pace of 0.5 per community, our order pace improved to 1.8 per community in January and accelerated to 2.8 per community in February. Part of the demand improvement we have seen can be attributed to mortgage rates coming off their highs, but an equally important factor has been our ability to be more responsive with pricing and incentives now that we've closed out a majority of our high margin backlog.
"We understand that most buyers are trying to solve for a monthly payment that fits their budget. And we have been able to address their affordability needs through some combination of base price reduction and financing incentives. We believe that this is a clear sign that there is demand elasticity in our markets and that there continues to be motivated new homebuyers at the right price."
It seems that we're finding the sweet spot between our price recalibration and what we're offering in terms of financial incentives to drive the right type of traffic and to get the right absorption rates back into our communities."

Rent Refugees & The 'Quick Close'

Mike Forsum, President and COO

We have recently seen an uptick in buyers coming from single-family rental situations who now want to own their home. Typically, these buyers want a quick close, and we have enough inventory in our communities that are at or near completion to satisfy this demand. Another positive recent development has been a noticeable improvement in the supply chain.
"Cycle times have come down 30 days from their peak as labor and materials availability have gotten better with the slowdown in activity. While most of this improvement is on the front end of the construction process, we are starting to see shorter lead times on key product categories that we need to get our homes closed."

No Resale Inventory? That's Ok

Mike Forsum, President and COO

We have roughly around 540 houses under construction, approximately around 100 or so or nearing total completion. That's dispersed around all of our 58 communities. So on average, it's not a lot, roughly around 2-ish [under construction per community], I would say, maybe more in some others and less than others.

But what we're finding is that the market is responding like a resell market. Most of our buyers are transacting in a period of 45 to 30 days. This is mostly around locking in interest rates that are favorable to them."

Consumer Outlook Amid Volatility

Mike Forsum, President & COO

We're feeling that the consumer is adjusting to the new normal, which is rates that are around that 5-ish, if you will, with a 5 handle on it. They know it's not going back to 3.5. They're looking at pricing, and they're seeing some adjustments that are being made, but they're not looking at radical price adjustments. The resale market continues to be very low. So their options are limited.
And we're seeing people coming out of rentals. They've been there for a year, their leases are coming up. They're seeing their rental rates going up, and they're seeing this as an opportunity to jump into the new housing market. And I think we're capitalizing on that.
I will say though that probably the more attracted to our smaller square footages and lower price points, which you would expect. But we believe that we have a really wide array of attractive products that are available to them. And we have inventory that we can deliver in that 45 to 30 day period.

The plot line, then, sounds a lot like homebuilder strategies from downturns past, ... only different.

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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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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