Homebuilders change their focus from move-up to entry-level buyers as sales wane in the move-up market and more Millennials buy entry-level homes.

Homebulders typically provide product for all levels of the housing market. However, after the housing bust, most homebuilders completely abandoned the entry-level market, leaving this market segment vastly under served — sort of.

The main reason homebuilders quit building this product is because for many years, they couldn’t sell it. The Great Recession forced many Millennials, the next generation of buyers, to live with their parents or rent an apartment because they couldn’t earn enough money to pay of their sizable debts and save for a down payment. So while the need for entry-level housing was great, there was no measurable demand for it. This need hasn’t gone away, but only now are Millennials getting on their feet financially enough to generate real demand and start buying homes.

(See: Imprudent student debt debilitates Millennial home shoppers)

While Millennials were getting their act together, Homebuilders were slowly building homes for the move-up market. Unfortunately, they raised prices too high too fast, and they found themselves producing a lot of product for a thin market. As a result, sales have been poorer than expected.

CIARAN MCEVOY, 2/24/2016

New-home sales fell in January to a seasonally adjusted rate of 494,000 units, the Commerce Department said, a sharper decline than economists forecast. January’s number also came in below the low end of economists’ estimates. New-home sales fell 5.2% compared with a year earlier and declined 9.2% from December’s rate of 544,000 units. The median sales price for new homes was $278,800, while the average sales price was $365,700. The median price fell 4.5% vs. a year earlier, the biggest drop since January 2012.

This looks more bearish than it is. New home sales fell because prices were too high. The move-up market is now saturated, and builders are transitioning their production to provide more entry-level housing; since entry-level housing is less expensive than move-up housing, the change in mix is causing the median sales price to drop. This trend will likely continue as builders start providing more entry-level housing in the years to come.

So why are builders making this transition? I recently had a conversation with a developer who watches the activities of SoCal homebuilders very closely. He noted that sales at developments priced under the conforming limit are selling far better than those priced above, which is consistent with the anecdotes from the post Story of a self-reliant Gen-Xer’s first time home purchase. The market is finally giving homebuilders the signal that now is the time to start providing entry-level housing.

March 4, 2016, Brena Swanson

Millennials are slow to enter the housing market, and there’s an extreme shortage of inventory in the housing market, anyway. So which problem gets solved first? An article in TIME by Denver Nicks highlighted the issue and said: This is the first time in the supply history of housing where, for whatever reason, a giant new generation is not being served,” G.U. Krueger, a Los Angeles housing economist, told The Los Angeles Times. ”To me, it’s incomprehensible.” To some degree, it’s a chicken-or-the-egg situation. Are builders not catering to first-time homebuyers because the nation’s young adults aren’t likely to be purchasing? Or are young adults unlikely to be buying partly because there are relatively few homes that match their needs? Either way, both areas are finally expected to take off over the next few years.

There’s no chicken-or-egg problem here. The lack of supply is a combination of no new homes being built and many entry-level houses trapped in cloud inventory. While these shortages provide the anecdotes for many stories, the reality is that demand, as measured by real dollars spent by real buyers, is also very weak — so weak that builders couldn’t sell enough of these homes to make it profitable for them to do so.

The most recent homebuilder confidence report recorded that homebuilders exhibited some optimism for the coming months. “Looking to 2016, at least a few public builders are opening or planning to open subdivisions in outlying communities and offering more affordable housing targeted to first-time buyers, including MDC, Meritage Homes and, especially, D.R. Horton,” Fitch stated.

Builders must change their production from move-up to entry-level housing, due to ongoing sales weakness in the move-up market. This transition is painful as demonstrated by the weak sales and falling median sales prices. This isn’t the sign of a big decline in homebuilding, but rather the transition from a lower volume and higher price market to the higher volume and lower price market for first-time homebuyers.

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