North Texas home sales are receiving a welcome shot in the arm this spring after mortgage interest rates plummeted back near 4%. New home sales have certainly benefited from the Fed’s capitulation on policy normalization.
If you are in the market for a new home, those high prices look more palatable with cheaper mortgage financing options. Buying a new home can be a great experience for customers who understand the process. Buying new construction also can be one of the quickest ways to become an underwater borrower if you don’t understand the market.
Market cycles are a natural business process. Homebuilders were riding the wave of the Fed’s cheap liquidity during the last decade, and things were looking pretty good for the new home industry until the modest increase in rates caused some serious problems.
The problem, of course, is that asset prices, and particularly new home prices, were goosed back to new highs. Home price growth exceeded wage growth by a wide margin. As affordability levels worsened last year, buyers began to question the merits of a buying a new home and builders were left with a lot of expensive homes that were more difficult to move. All it took was a modest rise in the 30-year fixed-rate mortgage to nearly 5% to bring the housing market to its knees.
Affordability levels were very poor in the Dallas-Fort Worth area, and home sales began to falter as rates ticked higher. The sudden dip in the stock market in December was a wake-up call that the economy was ill-equipped to deal with higher interest rates.
The Federal Reserve grossly overestimated the strength of the economy. It completely underestimated how dependent the housing market is to super cheap credit. Like the housing market, the U.S. economy is now addicted to artificially low rates, and this is why Federal Open Market Committee officials have done a complete U-turn on policy to keep markets afloat.
The dynamics playing out in the housing market can make shopping for a new home extremely complicated. Endless central bank liquidity has turned the housing market into a bifurcated mess, and builders have responded to affordability concerns by shrinking home sizes to keep price points down. It’s like the bag of chips you buy at the grocery store that can often be filled with a large air pocket. The manufacturer keeps the price level, but you get less and less product for the same price.
One of the more interesting developments in the DFW market is that the median price per square foot of new homes was still climbing until it dropped from $135 in February to $133 in March. The average price per square foot of new DFW homes peaked in June at $144, and the average total price of a new DFW home peaked in June 2017 $398,559.
Home shoppers in Denton aren’t exactly inundated with choices when it comes to new construction. New-home inventory in the city of Denton is still smaller than the supply of new homes in Denton County. This helps to explain why you have some new home buyers paying over $150 per square foot for basic, entry-level homes in Denton in a neighborhood that is also a haven for a giant Wall Street landlord.
The community of Beaver Creek near C.H. Collins Athletic Complex is a new home development by LGI Homes catering to many first-time buyers. LGI even offers 100% financing options if you are strapped for a down payment.
That no-money-down scenario can become a big problem, however, when a real estate market begins to turn.
During the recession a decade ago, millions of homeowners became upside-down on their mortgages (owing more on the mortgage than the value of the home) when the market shifted. It was a painful lesson, and the response to the crisis was an abject failure on multiple levels. With home prices at record levels in many markets like Denton, creative mortgage financing is creeping back into the market to stimulate sales volumes.
LGI Homes has become even more “creative” with its sales approach, partnering with American Homes 4 Rent, selling new homes to AH4R as the company adds to its massive rental empire. At the end of 2018, AH4R owned 52,783 single-family homes in 22 states. Denton Central Appraisal District records show that AH4R owns 39 homes in the Denton area and 18 homes at Beaver Creek.
Beaver Creek closed what appears to be its first resale transaction last month, and it didn’t go well. Multiple listing service data show that the owner apparently sold the property for several thousand less than what the new home cost in 2018, and this would be before any selling expenses. Ouch!
One of the biggest mistakes I see new-home buyers make is purchasing a new home without first considering an exit strategy. If you aren’t sure how you would sell it, you might want to do a little more research before you get yourself into a sticky situation. Issues that might seem trivial in a hot new-home market can become much larger hurdles when it’s time to sell a used property.
With homebuilders shrinking the size of homes and squeezing the size of lots to keep prices in check, new-home buyers should carefully evaluate what they are paying for. New-home builders and their sales reps are in the business of moving inventory regardless of market conditions. That can lead to some unfortunate consequences down the road for unsuspecting buyers.
Many new-home buyers forget that the land (aka the real estate) is what generally appreciates in value. The improvement on the land (the home) has a significant deprecation component attached to it.
In layman’s terms, homes can and do depreciate in value. That depreciation factor often goes unnoticed until the market cycle turns. Just something to keep in mind.