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Strategies & Market Trends : The Residential Real Estate Crash Index
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To: Siddhartha Gautama who wrote (31404)5/17/2005 5:11:10 PM
From: Elroy JetsonRead Replies (1) of 306849
 
Each builder has a different cost basis in their land at each location. However, financial pressures dictate that builders aggressively lower the price of new homes during a slump regardless of their costs.

The reason seven large condo developers filed for bankruptcy during the last month in Miami is that builders cannot long finance unsold inventory. When building a high-rise condo, you have to produce an enormous amount of product at one time. If they don't sell at a profit, you either have to sell them at a loss or file for bankruptcy - and the lender sells them at a loss.

When I worked at Pardee Homes we had a slim 10% profit margin on their recently purchased land in Las Vegas and a rich 55% margin on the land purchased twenty years prior in San Diego.

The results of these different cost structures during a downturn had been predictable. Pardee quickly finished off the existing lots in Las Vegas at a loss, leaving the next large parcels unimproved.

In San Diego, Pardee systematically lowered their sales price on new homes, matching the decline in existing home prices. Once the price reductions had reduced Pardee's profit margin from 55% to 8%, Pardee was the only new home builder still building new homes in San Diego.

Unfortunately this level of sales was not sufficient to maintain Pardee's record of consistent annual increases in profits. Having anticipated this problem, Pardee had previously built condominiums which they rented out as apartments. They filed sales documents with the State and offered each condominium to the current tenants at 75% of current appraised value. Depending on the project somewhere between two thirds and ninety percent of the tenants purchased their units. The remaining units were sold steadily. Even during the worst slump in real estate prices, making a sale is possible if the price is low enough.

So yes, builders tend to be the most aggressive in reducing prices, both when they can afford it and especially when they can't.

Keep in mind - when home prices crash, there is only one thing that declines in price faster and further - the price of raw land. During the price decline during the early 1990s, land prices declined by as much as 95%.
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