Builders Resort To Price Guarantees As Turmoil Continues
>>>Why not just call it a free put. I wonder how often they will mark these to market. Smell the desperation. Can you exercise a put against a BKed organization?? I somehow think put holders are at the back of the line.<<<
DOW JONES NEWSWIRES
February 5, 2008 2:20 p.m.
By Dawn Wotapka
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--As the housing slump drags on, some builders have a deal for potential buyers: Sign a contract, and if the price of comparable homes drops before closing, you get the lower price.
Companies including KB Home (KBH) and Ryland Group (RYL) hope such "price protection" guarantees will lessen consumers' paralyzing fears about buying real estate whose value is falling and get them to the dotted line, bring in much needed cash and reduce high cancellation rates.
Los Angeles-based KB Home, one of country's biggest builders, is preparing to roll out its program in 35 markets nationwide this month. Ryland, which only recently offered price protection for the first time and now gives it to any buyer who asks, is looking to reiterate its value in the marketplace, said Eric Elder, senior vice president of marketing and communications.
"If that value changes," he added, "We'll share that risk."
It is a strategy shift for the ailing industry - one market barometer has its stocks down 50% in the last year - which initially resisted price cuts as the market softened. Builders first offered freebies like granite countertops, tropical vacations or discounted closing costs. Then, in September, Hovnanian Enterprises Inc. (HOV) held a national "Deal of the Century" bonanza offering discounts into the six figures, a move other builders quickly copied, even though it can drag down a neighborhood's value and incense earlier buyers.
Dramatic price reductions, however, haven't been enough. As the residential market continues to deteriorate, more buyers are having trouble securing mortgages and selling existing homes, whose inventories are near all-time highs. Dire price predictions have also spooked consumers: Wachovia Corp. (WB) forecasts nationwide home values could fall as much as 20% this year. The resulting barrage of chilling headlines has left builders fighting to reassure customers that now is, in fact, a safe time to buy.
"In this market, where everybody's kind of hypersensitive, anything to alleviate the fear factor and the concern about eroding equity, that is a wonderful idea," said Kelly Cobb, a North Carolina broker with Fonville Morisey, a Long & Foster Co.
The guarantees cover the base price and exact floor plan and can include existing inventory, already heavily discounted, though those deals generally close quickly, leaving less time for prices to fall. Determining a specific reduction is a process that blends art and science, Elder said, and varies by community. Moreover, the protection ends at closing, so longer-term price declines could still leave buyers owning more than the house is worth.
There is also risk for builders and no assurances this will work: Last year, behemoth Lennar Corp. (LEN) tested it in Florida, one of the states hardest hit by the downturn, but stopped.
Even after trimmed price tags, buyers could still decide to walk away, keeping cancellation rates elevated. And if prices decline during construction, companies could see gross margins, which hit 25% during the boom and have plummeted to razor-thin levels, further stressed. "Depending on how much lower prices could go down, it could mean moving from a profit to a loss or a deeper loss," said Robert Curran, Fitch Ratings' lead home-building analyst.
That's why some industry watchers think builders don't expect further significant price erosion.
"We've reached the bottom," said Ryan McGowan, president and CEO of Premier Communities, a small, private builder near Seattle that started offering a price guarantee late last year. McGowan, who has given several reductions in the $6,000-range, said the well-received offer hasn't "moved homes off the shelves."
Ryland, the nation's eighth-largest builder by 2006 closings, noticed robust Web and sales center traffic during its guarantee, held Jan. 25-27: The number of sales contracts increased "a good amount" compared with the same weekend a year ago. The California-based company now touts the guarantee in weaker markets, such as Las Vegas and Phoenix.
No. 5 KB Home started quietly offering its guarantee in Orlando in June, followed by advertising, ranging from direct mail to mall kiosks, in several regions late last year. Most markets now participate, said Vince DePorre, regional president of Midwest and Southeast operations.
Price adjustments have been "well into the thousands," but the company could not provide exact numbers. In the fourth quarter, KB Homes' average sales price fell nearly 12% and the housing gross margin dropped from 9.1% to negative 4.3% year over year.
Aspiring home buyer Alyce Medina wouldn't have recently inked a contract for a $304,000 home in Stockton, Calif., without KB Home's price promise or its offer to lock in her interest rate. "We would not put our family in any kind of risk," said the 37-year-old mother of two.
Jeff Gibbs feels "peace of mind" about the value of his $245,000 home being built, replete with crown molding and hardwood floors, that he contracted to buy near Phoenix. "If the market keeps on going down before I buy, I'm going to get the lower price and that means a lot," said the 28-year-old sales and marketing rep. "It's almost like they're thanking me for buying when I did." |
