Builders Seek Predictability By Timing Sales Closer To Closing
Would-be new homebuying customers and would-be homebuilders are fighting the same war from two different fronts, like surreal parallel realities. Both are now battling spiraling prices, the surging cost of borrowed money, a bevy of random and recognized constraints on supply chain, and now, a Federal Reserve bent on nothing more than targeting them in particular – homebuyers and builders – to stanch a hemorrhaging tide of inflation.
Both, buyers and builders, face exposure to sudden, material changes that impact their access to resources, their ability to move forward as they foresaw themselves doing, their near-term plan.
The big picture question – as we try to get above the fray and picture an endgame – is where this winds up. After rocketfuel money supply and economic stimulus straining against new home production in a capability straightjacket helped set inflation's juggernaut in motion, now policymakers are working overtime to figure out what mechanisms they can disable without crashing the system. Will the Fed succeed in slowing down the elevated and agitated pulse rate of market-rate new residential construction without inducing cardiac arrest?
What's the endgame? If the Fed succeeds – as it has pronounced it will by hook or by crook – what does that look like for homebuilders' business plans, tactics, operational priorities during as an outcome of that deliberate tightening of the spigot of demand to reduce the hyperbolic pressure on prices.
A normal and natural dividing line that separates what homebuilders can produce affordably and profitably from what their homebuying customers can pay for from their household wages, supportive parents, etc. – i.e. the "invisible hand" of the markets -- is no longer normal and natural. Rather, that dividing line – the zone of value creation for both private sector homebuilding firms and for households attaining a homeownership haven – is going through a wringer.
The pre-2020 COVID-19 outbreak "norm" is the ground builder strategists believe their businesses will settle on as their line of defense as their customers and they grapple with a triple hit to their payment power – i.e. the power to save for down payment, the power to qualify for mortgage money, and the power to keep up with principal, interest, taxes, insurance, energy, and travel to-and-from their now-reopening worksites.
That feeble trickle of new home activity out of the Great Recession that swelled to a grudging stream of business constrained more by supply capacity than growing demand, and seemed on the verge of breaking through, matching production capability with fully-open sluice-gates of four million Millennials reaching their prime homebuying lifestage.
That's the amalgam of a norm to which most homebuilding strategists believe will establish the new baseline. As the rates of explosive growth start to lose some steam, flatten, perhaps step change to a lower rate of growth – the one builders were modeling to before the s— hit the fan in 2020 – they're keeping a weather eye on the day-to-day metrics:
- Completions and settlements in a context of 30 to 60-plus day schedule elongation
- Absorption pace changes, sequential, year-on-year, and compared with pre-pandemic historicals
- Cancellations due to mortgage finance fall-out or change-of-heart on now being the "right time to buy", again comparing latest week and month benchmarks, not only to prior month, and same time last year, but to a "former normal" historical data point pre-2020.
- Digital and in-person traffic and conversion rates and "waiting lists" as each new release of homes and new neighborhood opens
- Mortgage qualification shifts and erosion
The moving targets builders are watching – ready on a dime to tweak pricing discounts and concessions, incentives, down payment programs, mortgage rate locks, and other tools to ensure their evolving expectations on closings, absorption rates, and operating margins are in step with reality as it declares itself.
The tactic both disciplined public and private builders have adopted in this first-line of defense to secure their respective backlog orders with deposits is releasing batches of homes within a hard-stop completion range, that is later in the construction cycle so that any changes to both cost inputs and impacts to would-be buyers' access to mortgage financing can finalize without surprises on either side.
LGI ceo and chairman Eric Lipar, one of several public homebuilding company strategists in recent quarterly earnings commentary who spoke to the double-benefit – to both builders managing input cost inflation and to buyers' protection on both the selling price of the home they contract to buy and their ability to qualify for higher interest loan payments – of releasing homes under construction later in the process, gave a clinic on the tactic that shows the discipline of LGI's systems approach to changing circumstances.
The way that we're selling, to make sure the customer has a great experience and make sure we're hitting our closing dates and not having interest rate exposure and make sure we understand our costs. We are not putting any houses on our price list for sale until we are within 60 days of closing, which is around the first day of sheet rock in our construction cycle and by doing that we can limit our interest rate exposure.
So we sell a house within 60 days of closing. We are confident in the closing date delivering, when we're that close we take out a lot of the supply chain risk. The customer has a better experience. We have a better experience and have no interest rate exposure. So our backlog at the end of Q1 was 2,429 homes. And our assumption is that all of those or most of those are all scheduled to close in the second quarter. So, everything is locked and then those that aren't locked, going into the third quarter, the majority of those are cash buyers investors.
Now, the caveat around Lipar's disciplined tactical plan, and that of all of his peers, traces to a telltale macro reading on where the endgame point leaves the nation's homebuilders as the Fed's intentional economic frenzy wind-down plays out. Here's Lipar saying what every public homebuilder speaking to institutional investment analysts over the past six week period said in so many words.
Demand during the quarter was strong, supported by positive underlying fundamentals, including favorable demographics, low unemployment, a strong economy, tight inventory, rising rents, and the increased preference for homeownership born out of the pandemic. Nevertheless, prices of new and existing homes are up significantly and mortgage rates are expected to move higher. As a result, we are seeing signs that demand is normalizing from the unprecedented levels witnessed throughout 2021. We carefully monitor demand in each of our markets and while certainly not as hot as last year, we haven't seen the need to adjust our current course."
Lipar's own caveat comes with the words, "we carefully monitor demand in each of our markets."
That ground is shifting, and nobody knows where it will settle out in 2022 or 2023.