Further Freebies and Price Cuts Threaten Builders' Recovery

Date : 06/29/2010 @ 12:46PM
Source : Dow Jones News
Stock : Hovnanian Enterprises Class A (HOV)
Quote : 2.56  0.0 (0.00%) @ 4:03PM

Further Freebies and Price Cuts Threaten Builders' Recovery

Lennar (NYSE:LEN)
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Builder Lennar Corp. (LEN) might have slashed some prices more than 15% here, but that's not enough to jolt potential buyer Linda Primm to action. Not now that the federal home buyer tax credit has expired.

"As far as being in a rush now, no," she says, as she tours the loft-like second story of a model home in the Rancho D'oro community, one of many to spring up in the desert here in recent years. "What are you going to get? Nothing."

Without the credit offering up to $8,000 traffic and deals have fallen off a cliff nationwide, dragging sales to a record low in May. Builder KB Home (KBH) last week said its second-quarter orders plunged 23%.

Some nervous builders are responding by boosting the freebies they include with purchases, and cutting prices particularly given they built extra homes in recent months. While such offers have long been a part of the business, further price reductions and profit-eroding incentives reduce revenue. That will deal the fragile sector yet another blow, possibly delaying recovery until 2011.

"The rest of the summer and the fall are going to be tough for the builders," says Demir Gjokaj, a Majestic Research analyst. "Demand has remained far weaker for far longer than builders expected. Price incentives can't rebuild the spent demographics that cratered demand. That will take time."

For now, it's impossible to know how many excess houses went up: Tax-credit buyers have until Wednesday to close deals, while contracts can be cancelled anytime before closing. Builders promise they were careful: Investors will know more as companies report quarterly results in coming months.

Of course, some builders vow to keep prices stable. But increased incentives and price cuts anywhere typically have a rippling effect, forcing both public and private builders to follow.

"If one major builder cuts, it's a race to the bottom, because they're all going to cut," says Stephen East, a home-builder analyst with Ticonderoga Securities. "Suddenly, you're right back at square one."

Specials are clearly out there. In addition to the discounts at Rancho D'oro, Lennar is quietly offering a 3.25% adjustable-rate mortgage to some buyers. Others can tap a 3.75% rate--more than 1% below the current average-- fixed for 30 years. To offer such specials, builders typically make upfront cash payments to mortgage companies, a process known as a "buy down."

Standard Pacific Corp. (SPF) recently bumped up incentives by "a few thousand dollars" in many communities, effectively whittling prices by 1%, says Chief Executive Ken Campbell. Hovnanian Enterprises Inc. (HOV) promises "incredible savings" largely credit for options and upgrades--in New Jersey.

Unlike a few years ago when circuslike advertisements highlighted builders' desperation nationwide companies are targeting specific regions and communities. At Standard Pacific, "every market gets to do its own thing," Campbell says. "They do it differently from neighborhood to neighborhood depending on demand."

The steepest discounts will likely be found on speculative construction built without a signed contract. Because buyers can't pick out their own colors and upgrades, the homes can require discounts to sell.

Builder DR Horton (DHI) leads the sector with 7,300 spec homes, according to JP Morgan. The average is 1,344.

"Inventory overhang does not improve with time," says Jody Kahn, a vice president with John Burns Real Estate Consulting. "The longer those houses sit out there, the more likely it is that the builders have to reach deep in their pockets to move them."

-By Dawn Wotapka, Dow Jones Newswires; 212-416-2193; dawn.wotapka@dowjones.com


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