{"id":4917,"date":"2023-12-12T14:00:27","date_gmt":"2023-12-12T14:00:27","guid":{"rendered":"https:\/\/frankbuysphilly.com\/builders-rediscover-a-tool-from-the-1980s-that-keeps-new-home-prices-from-falling\/"},"modified":"2023-12-12T14:00:27","modified_gmt":"2023-12-12T14:00:27","slug":"builders-rediscover-a-tool-from-the-1980s-that-keeps-new-home-prices-from-falling","status":"publish","type":"post","link":"https:\/\/frankbuysphilly.com\/builders-rediscover-a-tool-from-the-1980s-that-keeps-new-home-prices-from-falling\/","title":{"rendered":"Builders rediscover a tool from the 1980s that keeps new home prices from falling"},"content":{"rendered":"
\n<\/p>\n
While sellers of existing homes have struggled with rising rates<\/a> and softening demand, homebuilders<\/a> have not only survived, but thrived in this market thanks to the use of mortgage rate buydowns<\/a>, a tool more widely used by builders since their business is selling homes and clearing inventory. Research from the AEI Housing Center<\/strong> found that these buydowns are not only an effective tool to qualify income-constrained buyers and alleviate excess inventory, but they have also allowed builders to forgo home price cuts. <\/p>\n Homebuilders had a less-than-ideal beginning as 2022 dawned. After a long period of rate repression, the Federal Reserve<\/strong><\/a> began aggressive monetary tightening, which would ultimately send mortgage rates to their highest levels since 2000. As affordability worsened, potential buyers were forced to pull back. Meanwhile, inventory<\/a> for new homes soared to levels last seen during the Great Financial Crisis as builders worked off the backlog<\/a> accumulated from the pandemic\u2019s construction boom. <\/p>\n To overcome these headwinds, builders quickly turned to lowering mortgage rates through permanent rate buydowns \u2014 a tool last widely used in the early 1980s when the rates exceeded 12%. This phenomenon becomes clearly apparent when compared to existing home sales, for which these buydowns are very rare. As shown in the chart below, existing and new home sales for the 19 largest home builders had roughly the same note rates until January 2022.<\/sup> However, once rates and inventory levels started to rise thereafter, a growing gap emerged between the two series. The gap peaked in November 2022, when the average note rate for new construction sales was one percentage point lower than the rate for existing home sales. As of July 2023, the gap had slightly narrowed to 0.8 ppt.<\/p>\n * Limited to loans with CLTV 76-80 and FICO 720-770 to control for the effect of loan level pricing adjustments.<\/p>\n Note: Data are for 30-year fixed rate primary-owner occupied purchase loans.<\/p>\n Source: AEI Housing Center, www.AEI.org\/housing<\/a>.<\/p>\n Their ability to effectively utilize buydowns in a high rate environment has provided homebuilders a competitive advantage: Not only are they able to sell more homes, they are also able to sell these homes without cutting prices. According to Census Bureau<\/strong><\/a> data, new home sales in September 2023 surged to the highest level since February 2022, while existing home sales plummeted. On top of that, prices for existing home sales had dropped noticeably, while prices for new home sales had slightly accelerated.<\/p>\n Based on AEI Housing Center\u2019s constant-quality home price data, new home sale prices have far outpaced prices for existing homes during the high rate period \u2014 a clear trend reversal from the low rate period. From Jan. 2022 to Dec. 2022 (the latest data point available), existing home prices have appreciated by 3%, while new home prices have appreciated 14%. <\/p>\n * Series ends in December 2022 because AVM tends to equal the sale price if the sale date is less than six months prior to the AVM date (June 2023 in this case). This particularly affects new home sales as they have fewer comparable sales.<\/p>\n Source: AEI Housing Center, www.AEI.org\/housing<\/a>.<\/p>\n Unlike individual home sellers, builders, due to their size and scale, were much better positioned to adapt to the new market conditions. Their use of rate buydowns is facilitated by the use of \u201cbulk forward commitments,\u201d where builders buy large pools of money at lower rates in advance. This can either be done by locking in rates as a hedge or by paying the lender a bulk buydown fee. Helping to absorb the cost of \u201cbulk forward commitments\u201d are builders\u2019 strong profit margins during the housing boom following the pandemic. As we will demonstrate, permanent buydowns can achieve a similar level of affordability at a lower cost and less market impact than a price cut. <\/p>\n The AEI Housing Center\u2019s data clearly reveal the use of large-scale forward commitments through rate bunching at particular points. For example, in November 2022 when the average note rate for existing home sales was at 6.75%, almost 90% of new homes sold by DR Horton had a note rate below 6% with clear bunching at 3.99%, 4.75%, and 4.99%. <\/p>\n Note: Data are for 30-year fixed rate primary-owner occupied purchase loans. Bin width is 0.125.<\/p>\n Source: AEI Housing Center, www.AEI.org\/housing<\/a>.<\/p>\n There are three distinct reasons for homebuilders\u2019 reliance on rate buydowns.<\/p>\n First, they are far more cost effective than a corresponding price cut. The math is straightforward: Imagine a builder selling a $400,000 home to a buyer making $100,000 a year. Assuming a 30-year fixed rate mortgage of 7% with 20% down payment, the monthly payment would be roughly $2,100. In this case, the total debt-to-income ratio (DTI) would be 51% and would exceed the Fannie Mae<\/strong><\/a> or Freddie Mac<\/strong><\/a> DTI limit of 50%.<\/p>\n To reduce the DTI to 48%, the builder would need to cut the sale price by 10%. Alternatively, the builder can offer a 1 ppts. permanent rate buydown to 6%. In both cases, the borrower\u2019s monthly payment would drop to $1,900, which allows the borrower to qualify with a DTI below 50%. However, the cost to the builder with the buydown is only 3.2% of the sales price, or one-third of the cost of a price cut (see table). On the other hand, offering free upgrades such as a marble countertop, another strategy commonly used by the builders, does not help bring down the borrower\u2019s DTI at all.<\/p>\nThe beginnings of mortgage rate buydowns<\/strong><\/h2>\n
Rate buydowns helped builders ride out higher rates <\/strong><\/h2>\n
Permanent rate buydowns through \u201cbulk forward commitments\u201d<\/strong><\/h2>\n
Why builders prefer rate buydowns over price reductions<\/strong><\/h2>\n
Stylized comparison between a price cut and a mortgage rate buydown<\/strong><\/h2>\n