U.S. Homebuilders Mourn Loss of Free Down Payments

August 22, 2008
By: Helen Chernikoff, Reuters News?

On the surface, a U.S. housing law passed in July that provides first-time home buyers with a tax credit looks like a boon for builders.?

But even as the law will give to the industry, it will also take away, eliminating a long-standing incentive where builders enticed buyers into purchasing homes by providing the down payment on mortgages insured by the government.?

Known as "seller-funded down payment assistance," builders could pay up to 6 percent of a home's sale price. But from Oct. 1, the law will ban this practice because mortgages secured with assisted down payments have expected foreclosure rates up to three times higher than other loans, Housing and Urban Development (HUD) spokesman Lemar Wooley said.?

The ban is a near-term negative for the industry, since it will shrink the pool of potential buyers, raise cancellation rates and weigh on already-depressed builders' shares -- their index -- sits 75 percent off its lifetime high.

The chief executive of the largest U.S. home builder, D.R. Horton Inc , said he "got suicidal" over the ban.

"I'm absolutely shocked by it. And I'm upset by it," Horton CEO Don Tomnitz told analysts on a recent call. "To take 10 percent, 20 percent, 30 percent of the buyers out of the home buying decision, at a point in the economy that they did, it's absolutely ludicrous."?

While the new law contains a $7,500 tax credit for first-time buyers, that will not offset the ban on down payment assistance, which had no such restrictions, National Association of Home Builders (NAHB) CEO Jerry Howard said.?

The credit, which benefits buyers at tax time, is also not as intuitive as an up-front gift, one portfolio manager said.

?"It's still an incentive, it's just not as good an incentive," said Todd Lowenstein, whose HighMark Value Momentum Fund owns 181,000 shares of Pulte Homes Inc .??

What's more, builders had come to rely increasingly on down payment assistance as the credit crunch forced more buyers into the very government mortgages affected by the ban, Morningstar analyst Eric Landry said.

A BIG CHUNK

Assisted down payments secure about a third of the Federal Housing Authority's portfolio today, up from 18 percent five years ago, HUD's Wooley said.?

In reducing the number of potential buyers, whether or not they could afford down payments, the ban "could cause another leg down" for builders by depressing home prices further and forcing them to write off the value of more land, JP Morgan analyst Michael Rehaut said on a conference call for clients.

It could mean share price declines of another 10 percent to 20 percent over the next three to four quarters, Rehaut said.

Also, cancellation rates could rise because agreements to buy homes struck before Oct. 1 could see any assistance invalidated by a routine credit recheck after that date, said Bill Renner, NAHB's director of single-family finance.

Builders such as Horton and Centex Corp , which both target first-time buyers, will especially feel the loss because more of their customers need either financial help or a government-backed loan, or both.

?Horton assisted 21 percent of buyers in its latest quarter, up from 7 percent in all of fiscal 2007, while Centex assisted buyers in a quarter of closings.

?Lennar Corp tops the big builders with about a third of its closings using down payment assistance in the second quarter, spokesman Scott Shipley said.

?NO ESCAPE?

But no builder will escape the hit to first-time buyers.?

At this point in the cycle, a builder's focus is on luring first-timers, said analyst Jim Wilson of JMP Securities.

Meritage Homes Corp , the No. 12 U.S. builder, has talked about re-pricing communities to attract lower-end buyers. About 15 percent of its closings used down payment assistance last quarter, spokesman Brent Anderson said.

Even luxury builder Toll Brothers Inc , which does not offer down payment assistance (DPA), will be hurt as owners struggle to trade up, CEO Bob Toll said on a conference call.

"We would expect that the whole daisy chain of the market will be impacted to some extent," he said.

Still, some builders see the logic in the ban.

"The end of DPA will probably pressure industry sales in the near term, but over time, our buyers and the market will adjust," Centex Chief Financial Officer Cathy Smith said on a conference call. "We continue to believe that a return to more normal qualification standards is a very good thing long term, even if it carries with it a little short-term pain."

In response to the law's passage, Centex has developed a program that helps home buyers save down payment funds.

Pulte launched a promotion offering all customers $7,500 in savings in addition to the tax credit for first-timers.

While the DPA ban is a short-term negative, Wall Street has exaggerated its importance, UBS analyst David Goldberg said.

"It's a problem they're going to have to overcome, but they'll overcome it," Goldberg said.

# # #

For additional information, please contact Shelley Mitchell, smitchell@nehemiahcorp.org, 916-231-1999.

# # #