Homebuilders finding discounts working

In Stage 1 of a housing downturn, homebuilders first try out a variety of incentives such as free upgrades of optional items, allowances at the design center or paying non-recurring closing costs. But as their competitors start to match these incentives, to move inventory they must become more aggressive and sometimes cut list prices.

Understandably, builders hate to do this because it erodes the value of their investment, crimps whatever profit margins they have left and angers buyers who might have paid more for the same type of home (which is why price guarantees have recently taken off).

But discounts do work, as summarized in a story in the L.A. Times (and which also quotes yours truly):

Stuck with excess inventory, builders throughout California are beginning to offer steep discounts on new homes, sometimes at a loss. Centex Corp. is touting the "greatest prices in years" in its ads. In San Bernardino County, builder Van Daele Homes is advertising 35% discounts.Until recently, most builders resisted outright price cuts in California so as not to undermine the value of their holdings. Instead, many offered incentives such as big-screen televisions or interior upgrades.

But the incentives weren't working, builders now concede, forcing them to carry the debt on empty, unsold houses.

"Builders don't have the luxury of waiting another year for the market to turn -- they need the cash flow now," said Patrick S. Duffy, principal of Metrointelligence Real Estate Advisors, a consultant to home builders.

"It's better for them to take 90 cents on the dollar today than to risk no cash flow at all because they're not selling any houses," he added...

Home builders concede they had little choice but to slash prices given the sharp downturn in home sales and the credit crunch, which has made it harder for many borrowers to get home loans...

Centex, another major builder, said it resorted to price cuts because incentives weren't working and because many borrowers had trouble getting the "jumbo" mortgages they needed for higher-priced homes...

In addition to slashing prices, some builders are scaling down the size of their homes to make them more affordable...

Even with the discounts, however, many buyers remain on the sidelines, thinking the market has yet to bottom. To help persuade those people, some builders have begun offering price guarantees.

KB Home, for example, recently agreed to give buyers in some developments a lower base price if the selling price of similar homes in their developments in the time between the contract signing and purchase closing.

Tom DiPrima, president of KB Home's North Los Angeles division, said the policy had helped persuade reluctant buyers to take the leap and purchase.

"They've said it really gave them the peace of mind to jump into the market," DiPrima said.

DiPrima, however, also credits the role of lower price points.