Interest rates are still higher now than they were twelve months ago, causing buyers to continue to bail out of buying both new and existing homes. These higher rates have reduced sales and home prices.

Watching and Waiting

People have been paying close attention to rates—along with gasoline prices—and now, their jobs. Jobs are still reasonably stable, but there are more that are part-time and less with overtime. Gasoline prices are back to where they were a year ago, and interest rates dropped a bit. But are they going to come down, maybe where they were a year ago? Will they at least stop going up?

Even if we have seen the top—which I doubt—everyone is skittish because of the fast increases this year.

The Numbers

Today the 10-year Treasury note is yielding 3.82%. The 30-year fixed rate mortgage with 20% down is about 6.3% to 6.8% (down from around 7.25% at the peak a few months ago). The current prime rate is 7.75% (3.25% all of 2021); many homebuilders borrow at 1.5% over prime, and pay .5% to 1.5% in points. This means mortgage payments for homeowners are up 29% in a year—assuming no change in home prices. And for homebuilders, interest payments are up over 100%.

All of these rates will probably go up by more than 1.5 percentage points or drop by more than 1 percentage point over the next 6-9 months. Inflation is running 6.4% (down from its peak), and unemployment is 3.4%, about as low as it has ever been. This still gives the Fed plenty of motivation to continue raising rates and running off their portfolio of mortgage backed securities. As long as the Fed is raising rates and not buying mortgages, my bet is generally up for the prime rate and mortgage rates, which are the most important rates in our industry. That appears to be the direction until the second quarter of 2023, unless something breaks.

True to form, the best rates you can get from banks on savings accounts and 1-year CDs are about 4-4.5%. Pretty impressive from 0.1% or less last year! Oh, did I mention inflation is 6.4%? And the stock market is having fits, although up from its lows?

More Watching and Waiting

Homebuyers are paying about 30%- 40% more for their mortgages than they were a year ago, since home prices are up 5%-10%, too.  Even though prices have generally fallen from their peak, there are huge differences from place to place, even in the same city. Many of those increases are fast disappearing through discounting to keep people from cancelling, to attract buyers for finished homes where too many are standing, and to price that base home to the current market. Many homebuyers are cancelling not because they can’t afford the higher payments, but because friends and family members make them feel bad about buying now. Apparently they know the future of home prices and interest rates and they are willing to make your customer stay where they are rather than enjoy their new home.

Because interest rates have increased so much, and home prices in many areas have increased a lot, more and more pundits are calling for a big housing crash: many fewer units sold, and big drops in the price of housing, anywhere from 10% to 40%. All of this is either making people fearful that if they buy now, their housing investment will drop, or greedy that if they wait, you or someone else will discount the house a lot more or interest rates will fall. But is that true? How many times are builders going to keep building the same house and then discounting its price when it is finished?

So, what should we do about it?

Five Steps

1. Share the facts in your market with your customers and prospects. Share what your home prices have done over the past 2-5 years; in most cases, they have earned steady, not spike, increases. Share what a typical payment has done over those timeframes. Make sure you show what has happened to rental rates over the same time period. Show what construction costs have done and are expected to do. Share how fewer existing homes are being offered for sale, and why that is so. For people who need a new home, 2023 is still a relatively good time to buy.  Compare the facts in terms of monthly payments. In most cases, mortgage payments are still less than rental payments! Even if the payment is higher, if interest rates fall in the next few years, as many are predicting, customers can lock in a reasonable price on their home now and refinance at a lower rate later.

2. Don’t promote rate or price discounts in your lead generation activities. Sure, if you have a customer who is interested in that, then talk about buy-downs or locks or discounts that you are willing to negotiate. But advertising discounts almost never attracts prospective buyers. Payment, downpayment, and the relative advantages of your new home versus where they are now is what appeals to buyers. Target your message to the needs of each of your buyer groups, focusing on the reasons why they need a new home.

3. Start attracting investors as lenders. The stock market is crazy volatile, and bonds and savings pay a 2%-5%.  Who wouldn’t mind getting 7%-10% by lending on model homes, homes under construction, and land that they can see when they drive by?

4. Stress test your sales backlog. If they can withstand a 50 basis point increase in interest rates, then go to your preferred lenders and ask for a ladder of locks or buy-downs for 25% to 50% of your backlog, but the interest rate is 50 basis points higher than today. So, if today’s mortgage rate is 6%, consider paying for locks for 20% of your backlog at 6.5%, 20% at 7.0%, and 10% at 7.5%. This is insurance, just like fire insurance. At least get a quote from a preferred lender or two to see what this kind of “cancellation insurance” might cost you. And make sure your buyers know that you will keep all of their deposit if they cancel because of interest rates rising.

5. Really manage inventory well. This includes finished homes and models, homes under construction, finished lots, and lots under development. Your interest carrying costs have more than doubled from last year. You didn’t have much finished inventory, whether models, spec homes or lots, but that is changing. Don’t start homes without an adequate gross margin. Don’t start spec homes unless you sold the same floor plan and your spec inventory stays the same or falls. Develop new lots based on your current absorption rate. Check out selling and leasing back your models, especially to local friends and family. And if you have standing inventory, make sure it is priced to the market, and that you have excellent and diversified lead generation vehicles (including old-fashioned fixed signage, direct mail, and events) before you start with big discounting. When discounting, avoid discounting the base house, instead, work with your options and upgrades.

For more advice on overcoming the challenges facing the house industry, join us in Fort Lauderdale, March 6-8, for the 2023 Executive Summit. This is a must-attend event for home builders interested in implementing winning strategies proven to work in down markets to emerge on the other side stronger, more profitable, and in a better position for growth.

Jim Weigel is a senior consultant at Shinn Consulting. He specializes in helping builders implement effective management systems with a focus on disciplined leadership and performance excellence to increase revenue. Jim’s areas of expertise include management, marketing, sales, finance, quality, valuation, owner transition.

FREE WEBINAR: Join us on Wednesday, March 15, for Jim’s webinar and Q&A session titled Transforming Your Business: 3 Tips to Improve Profitability TODAY. Click here to register.