Home Builders Learn from Car Dealers

Trade-ins are a growing trend in the hard-hit new-home industry. It may just be the ticket for buyers in a slow market.

By Peter Goldstein, Senior Economics Editor, The Kiplinger Letter

Matthew Mogul, Associate Editor, The Kiplinger Letter

June 18, 2007

Want to buy a new home? Worried about selling the one you own? Try a trade-in. Anyone who has purchased a car is familiar with the trade-in routine, where the dealer takes a potentially hard-to-unload older model off the buyer's hands. Now, with new-home sales in the doldrums -- down nearly 11% from a year ago -- many home builders are encouraging trade-in options, offering to buy the residences of potential customers to save them the hassle of seeking out buyers in a sluggish housing market.

The trade-in option is just one of many incentives being dangled in front of prospective buyers, from deep discounts to kitchen upgrades to memberships at country clubs -- anything to clinch the sale. In many ways, the moves smack of desperation. The last time builders employed such tactics was in the early 1990s, during the last big housing bust. Builders are anxious to clear inventory from tracts of newly built homes. Simply put: A cluster of empty units in a given community doesn't look good and can precipitate a price collapse.

The real kiss of death of builders is the rising number of order cancellations, which have ballooned to nearly 30% of all new homes. That's up from just 1% during the height of the housing boom in January 2005. And with mortgage rates starting to pick up again -- the average on the popular 30-year fixed mortgage has jumped to 6.7% from 6.1% last month -- it's likely that cancellations will soon reach the 35% level. Look for more home builders to roll out some form of trade-in deal in an effort to prevent lost sales.

"Right now, we're seeing this in select areas, in communities where it makes sense," says California real estate consultant John Burns, who singled out Arizona, California and Florida as locations where the bulk of trade-ins are taking place. "Even though it's still a small percentage of home builders [doing them], the whole industry is full of copycats. If others see it makes sense, they'll jump on board and do it, too."

The process can be a win-win for both buyers and sellers. Home buyers, for instance, typically avoid the usual commission costs paid to real estate agents, and home builders can arrange closing for buyers within a month. They also have the peace of mind that they won't get stuck paying two mortgages, two property tax bills and two homeowners insurance policies. Plus, home builders generally offer a decent price on the trade-in, worth upwards of 90% to 95% of the appraised value.

Builders, of course, receive the benefit of working down their swollen inventories. In addition, they have the construction resources to give older houses quick makeovers to increase their market value. Many builders also have either their own sales and marketing people or trusted industry contacts able to sell the home quickly. And even when the sale doesn't come so easily or at the price the builder had hoped for, it still works out to be the lesser of two evils: Any losses are likely to be marginal -- much less painful than sitting on a whole bunch of unsold newly built homes that are losing value.

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