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New Home Demand Curbs Lot Prices

Market conditions over the past six months have impacted several aspects of the housing sector. Increased mortgage rates and the recent government shutdown have proceeded to stall the recovery process. Newly built homes, in particular, were subjected to fewer sales, as homebuilders gawked at the idea of paying increasingly higher prices for empty lots. However, the recent decline in new home sales projects to curb the recent growth we have seen in lot prices. New home prices, as a result, may regress.

According to the U.S. Census Bureau, respective lots have increased in price since 2011 and are currently at levels we have not seen since 2008. On a national average, lots cost more than $300,000. Assuming that land typically accounts for 40% of a home’s price, curbing empty lot prices may increase home affordability.

Finished lots, represented by a foundation ready for construction, have become a commodity for investors and construction companies. As a result, bidding wars have facilitated an exponential growth in their price since 2011. For the majority of the recovery, lot prices proceeded to increase. However, it appears as if the recent trend may be at an end. As new home sales continue to settle, builders are less willing to pay the prices these lots demanded in the past.

Ultimately, the decrease in new home demand has curbed the growth of lot prices.

According to Zelman & Associates, a housing research and advisory firm, the growth of lot prices has been tempered. Lot prices have gone from a gain of nearly 7% in the first quarter of 2013 compared with the previous quarter, to gains of about 6% in the second quarter and 4% in the third quarter

“Demand and prices had been increasing at unsustainable rates,” says Larry Seay, chief financial officer of Meritage Homes Corp., which sold 4,484 homes in the first nine months of 2013. “It is good for the industry to take a little breather, let the land market moderate and get to a more normal rate of growth and house-price appreciation.”

As expected, lot prices have been nothing less than volatile in the wake of the housing sector decline. In fact, finished lots demanded 55% to 60% less than their 2006 peaks.

It wasn’t until 2011 that we saw a resurgence in lot prices. Depleted inventory levels and an unexpected demand for property forced landowners to demand a premium. For example, finished lots in a suburb of Sacramento that sold for $120,000 in the first part of 2012 jumped to $220,000 over the first half of 2013. This was happening on a national level.

As was expected, the surge in lot prices proceeded to increase the cost of new homes. The average price of a new home in the U.S. reached an all-time high of $337,000 in April. During the housing crisis, the average dipped as low as $245,000 in January 2009.

However, several factors resulted in warranted trepidation over the acquisition of property. Double-digit percentage increases in new-home prices and a 1 percentage-point increase in interest rates between May and September facilitated a feeling of uncertainty within the housing sector. Buyers were simply scared to actively participate in the market.

As the demand for new homes began to decrease, builders had to reevaluate their land acquisitions. What they were willing to pay in the past has not transitioned over into the new market. Builders are even asking to receive a lower price on the land that they have already purchased, a practice known as “retrading.”

Lot prices have lost some of their upward momentum, and in a few markets they are declining. “There are fewer bidders for the highest-priced land despite the quality of the location,” says Reed Porter, president of builder Ryland Group Inc.’s Arizona division.

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