The Housing Chronicles Blog: Builders offering price protection against further declines

Thursday, February 7, 2008

Builders offering price protection against further declines

In a potential sign that builders don't expect prices for their homes to fall much further, both KBHome and Ryland are offering what many skittish buyers need: protection against falling prices. From an article in today's Wall Street Journal:

As the housing slump drags on, some builders have a deal for potential buyers: Sign a contract, and if the cost of comparable homes drops before closing, you get the lower price.

Companies including KB Home and Ryland Group 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 the 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...

It is a strategy shift for the ailing industry -- one market barometer has its stock prices 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. 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. 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...

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...Moreover, the protection ends at closing, so longer-term price declines could still leave buyers owing more than the house is worth...

There is also risk for builders, and no assurances this will work: Last year, behemoth Lennar Corp. tested it in Florida, one of the states hardest hit by the downturn, but stopped.

Even after price tags are trimmed, 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.

Some industry watchers think the offers mean builders don't expect further significant price erosion.

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