Assuming new condo prices will fall? Not if they can rent 'em...

Monday, November 26, 2007

One key problem with offering incentives and price cuts to buyers of new homes is that they're likely to assume that if they wait there will be even better prices down the road (similar to my own reasoning for waiting to buy a 52" LCD TV until after Christmas). As discussed in The Wall Street Journal, when EVERYONE offers incentives or price cuts they're no longer special. It's a lot like dating -- people always want what they can't have, and don't appreciate what's offered too easily to them. So what to do, play the field and postpone a commitment or jump now?

If you wait too long, you might risk your favorite future home becoming a rental, as is apparently happening to some high-profile condo projects in downtown Los Angeles and North Hollywood.

During the last housing recession of the early 1990s (and I worked in this industry through all of that and tracked incentives and price changes closely) builders took much longer to enact price cuts and incentives were more of a novelty, so even though buyers shopped incentives more than homes or neighborhoods (which I always thought was a stupid thing to do), the slower pace and shallower price cuts left buyers with more confidence that values would not fall any further.

This time -- and in an effort to 'find the bottom' faster than the market might do otherwise -- builders offered incentives much more quickly and enacted price cuts as soon as their competitors had matched common incentives such as discounted or free upgrades, financial assistance and non-recurring closing costs.

But that was only Round 1, which involved builders cutting into fat (i.e., profit margins). Round 2 -- in which we are currently involved -- involves builders cutting into muscle (hence the numerous job layoffs) by offering a scope of incentives and price cuts designed to move inventory on the practical theory that bringing in any cash is better than no cash at all. For most builders it's now all about servicing debt loads, whether it's in the form or land or bonds.

At some point a builder (such as Lennar, which has decided instead to postpone developing some projects) or a builder's lenders, partners and investors will no longer approve any more price cuts, because if they can't service their debt then the entire reasoning for the price cuts is gone. Hey, why sell now if the loan's already going into default? Might as well wait to renegotiate the terms, maybe mothball the project or rent it out and come back another day.

If a bank is forced to take over existing projects due to a loan default or a bankruptcy, their price cuts could be much less than what the builders would offer because their time horizon is different, plus what happens to customer service if a bank is forced to sell off a bankrupt builder's assets? It's much better to deal fairly with a builder who will be there well after the sale and not be so short-sighted to demand price cuts that imperil a company. Few things are more important after buying a new home than customer service; who would you rather call when you want to claim a warranty item -- the homebuilder or an 800 number at B of A?