The Housing Chronicles Blog: Capturing the Elusive First-Time Home Buyer

Friday, July 24, 2015

Capturing the Elusive First-Time Home Buyer

During this year’s PCBC in San Diego, I was fortunate enough to moderate a panel of experts on the elusive first-time home buyer.  The purpose of the panel was to discuss the challenges in building, selling and financing starter homes for the often Millennial buyer and what we in the industry are doing to adapt to this important cohort.

Importantly, although the percentage of first-time home buyers has recently risen by a few percentage points from where it was a year ago, for most builders of new homes it’s a different story.  Whereas the share of new home sales versus the overall market has traditionally ranged from 15 to 20 percent, today it’s about half that, and unless that capture rate  rebounds closer to historical norms, new home starts will remain subdued.  Moreover, given that 2.5 to 3.0 times today’s national median household income would allow a sale price of about $140,000 to $160,000, it’s easy to see why building that starter home has become so problematic. 

On the product side, certainly the biggest problem to be resolved is managing the cost in terms of land, entitlements, labor, supplies and carrying costs, but many of those expenses are not in the builder’s control, which makes building entry-level homes even riskier.  City planning departments, which might have envisioned acres of single-family homes on generous-sized lots a decade or two ago in their mandated housing elements, are often inflexible and slow to adapt to the changing marketplace, and yet accept no responsibility for their negative impact on the potential housing supply.

Moreover, while building higher-density PUDs or condominiums can be a great theoretical solution, the toxic mix of paranoid neighborhood NIMBYs, opportunistic construction defect attorneys and buyers’ dislike of HOA fees – coupled with a fundamental misunderstanding of their benefits – often make such projects easier to build as apartments.

Still, there are some builders who have dipped their toes into this market with great success.  D.R. Horton’s Express Homes division was launched in the spring of 2014 and, along with their Regent Homes division (which is oriented towards a similar buyer), accounted for five percent of sales that first year.

By the second quarter of 2015, the capture rate of these entry-level homes versus the entire company had more than tripled to 18 percent (although given the average closing price of $179,000, the revenue capture rate was just eight percent).  Nonetheless, even with lower margins and a faster production schedule, the economies of scale enjoyed by a builder of Horton’s size can not only make such projects profitable, but introduce the builder’s name to a family who might be upgrading to their larger floor plans in the future.

LGI Homes, another Texas-based builder which began operations in 2003 and has sold over 9,000 homes, has oriented its entire business strategy towards the entry-level home buyer in nine different states.  This strategy seems to be working, with the company announcing an all-time record for monthly closings in June 2015, and also reporting that sales in the first half of the year were up one-third over 2014 levels.

So what is the secret to LGI’s success?  They stick to their knitting by relentlessly focusing on existing renters in apartments or single-family homes who don’t know they can afford a new home.  This starts on their company Web site, in which plans at specific communities don’t list a sales price.  Instead, they list what the monthly P&I payment would be based on an FHA loan with 3.5 percent down at current interest rates.  They then translate this same information into printed flyers that they mail out to renters within 30 miles of each project, and make sure they’re ready to greet potential buyers with sales offices that are open 12 hours each day, seven days a week.

It’s in these sales offices that most of the hand-holding begins, starting with free credit counseling for potential buyers who thought they were permanently priced out of the housing market.  LGI also builds in areas on the urban periphery which is technically considered rural by the USDA, which then makes some buyers eligible for their no money down mortgage programs.  For final peace of mind, LGI warranties its homes for 10 years and includes full kitchen appliance packages, fencing and landscaping.

Finally, LGI also has a robust Web site which is comprehensive and easy to navigate.  In a world in which a poorly constructed Web site is a company’s perceived digital strategy, you can’t blame the Millennials if and when they opt to look elsewhere.

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