Have you ever used the crop feature to edit a picture? Maybe the photo was a little too wide, and you wanted to tighten it up. Perhaps you wanted to crop out a person you used to date. Regardless, when you change the way you frame a picture, that picture tells a different story. Cropping enables you to focus on what you want to see. It can be useful, but it also can be dangerous as cropping an image allows you to alter the truth of the image.
Take mortgage rates, for example. What do we see from the image below, which shows you the long-run trends on mortgage rates over the last several decades going back to the 1970s?
If you see what I see, then you see that rates are still at historic lows and anyone who secures a long-term mortgage rate where they are today is lucky. What a great time to buy, right?
But what happens when I crop that image and zoom in, and we look at the same graph, but starting in 2010? What picture do we see? And, more importantly, what story emerges for people considering purchasing?
This still looks pretty good, right? We’re below the post-recession high of roughly 5.5%, even as rates have crept up, and we’re still more than a full percentage point below that post-recession high. It seems like there is still a great opportunity here, right?
What if we crop and zoom just a little further to begin in 2013?
The picture is starting to change, isn’t it? Rather than being able to finance at historically low rates, I’ve now missed the bottom and rates are climbing. The raw impact of this trend line is that a borrower today can’t afford as much as they could have a few years ago. Consequently, borrowers may feel like they’re “losing,” relatively speaking.
However, this isn’t the only picture that matters. To fully grasp the forces at work, we need to include at least one more variable— new construction pricing. If you regularly read my columns, you know I’ve written extensively about the supply side issues that are driving up pricing beyond real value. You don’t have to take my word for it though, Metro Study’s most recent economic report for builders said the same thing. New construction pricing is above its real value given the impact on the supply side.
For simplicity and length, I’ll spare everyone the three-step cropping process and just zoom us in on new construction pricing over the last decade.
The snapshot above captures the final years of the recession forward. For context, if I showed you the full graph, it would look like a long-run increase, which shouldn’t be surprising because we’re talking about housing over decades of time. The recessions have essentially acted as short-term blips in a long-term climb. That includes the Great Recession.
So why does all of this matter? And why am I putting the two of these things together this way? The answer is affordability. Over the last ten years, the median new construction price has gone up by more than $100,000, which is essentially a 50% increase. What happens when you add a 50% price increase to climbing interest rates (29% higher since the low of 2013)?
You get downward pressure on affordability at the same time as you have increased pressure on pricing and, not shockingly, demand slips. Want to know what happened in the last six to eight months? This is what happened.
You can’t continue to have climbing prices from supply-side drivers and climbing interest rates and expect demand to increase, or even remain flat. That combination will necessarily drive demand down. Homeownership rates have climbed a bit since their post-recession lows, but they’re basically still in line with the long-run trend lines (excluding bubble periods).
Flat demand plus rising costs plus rising rates isn't a very good recipe. Now that I’ve stated the obvious, let me offer a few suggestions.
First, this is national data, but you can look at the same questions on a local level. Perhaps the trends are different. If so, great but if not, you need to adjust. This means re-examining every land position you have to make sure you’re bringing the product to market in a price band where you can verify demand. This could mean adding smaller plans and looking at your feature mix with a focus on cost savings (things buyers don’t value). If you don’t do this, more and more of your share of the market will shift to resale.
Second, try not to assume you can create demand. Don’t assume the reason there aren’t many transactions at a given price point is that supply is low. It’s more likely that demand at that price point is low, and it's highly unlikely that you can actually create demand if you simply provide the supply. If you don’t have data to show an unmet demand, assume it doesn’t exist. This is particularly true for the higher end of the market in any given area. I know your supply-side costs are pushing you to compete in higher price points than you want, but don’t take the bait unless you have some rock-solid data and your team actively attempts to poke aggressive holes in it.
Third, take time to develop a strategic land plan right now. Not sure how? Not sure your team is doing that effectively enough? Not sure how to consider developing a land plan that integrates a strategic consumer segmentation process that aligns your land search strategy and your product strategy with your consumer? The time has come to call New Home Star.