The Tight Starter Home Market
Each buyer is unique and the desires are more diverse than many earlier groups of buyers.

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“The first-time buyer market is there if the homes can be affordably priced,” he says.

Cleveland agrees, saying that the pool of interested buyers for starter homes is growing.

“Consumer confidence continues to rise –which is critical,” Cleveland says. “Not many folks take out a 30-year mortgage if they are worried about getting laid off from their jobs. Wages are rising and unemployment is extremely low. Couple these factors with still low interest rates and I think the demand for new homes is going to continue to grow.”

While demand is not where it was before the Great Recession, that’s probably a good thing as that was a period driven by unreasonable growth and unsustainable price increases.

“The market got way too hot in the mid-2000s driven by ‘easy money’ from the banks to build homes and unrealistic expectations (my opinion) from buyers that prices had no place to go but up,” Cleveland says. “Obviously, that ended badly.”

As demand has increased, so has the expectation of the new home buyer. Buyers of starter homes today are expecting more than they were a decade ago, making it even tougher for builders to make money on the segment.

“Folks in that price range just expect the world, and you can’t give them that,” Herbert says.” You know, TV is probably our worst enemy. Everybody thinks that you can do all this stuff that you see on these TV shows. They think they can afford that in their very first house. Then you go in, you got to put granite in them, and all these upgraded features, that takes your affordability factor out.”

Sometimes that will kill the deal, with the builder having to be “the bad guy,” disappointing the buyers with what they can get for what they want to pay. “Sometimes buyers will choose to upgrade, but many won’t,“ Herbert says. Buyers are also often looking for Herbert to pay their closing costs or add it into the price of the home for financing, making it tough to maintain profitability with already narrow margins.

“When it was a recession, and you had 20 or 30 houses sitting on you, you’d pretty much give up your whole profit margin, just to make a deal happen, and get the debt off of it,” Herbert says. “But times have changed dramatically now.”

A builder has to know his numbers and what it will take to make the necessary profit. While every company will have to make its own decisions, Herbert knows where he needs to hold the line. And sometimes that means telling a buyer no. Often, it’s simply a case of buyers not understanding the way a home is priced and the fact that the $200,000 house is not $200,000 in the builder’s pocket. Walking through the numbers with a potential buyer can be an important step in the process.

“You try and gross 15 percent on the house, and it takes roughly 10 percent, in your basic overhead, just to operate,” Herbert says. “At least you have a 5 percent profit margin. … If a buyer wants you to give them $5,000 worth of closing costs, and you only have $2,000 calculated in ... Let’s say, it’s $160,000 on the house, and you got a $9,000 profit margin, they want you to give up $3,000 of that to help them, that’s 33 percent of your net profit. They don’t think of it that way. They just look at things differently.”

First-time buyers are also more likely to face credit and financing challenges.

“Typically the two biggest challenges are down payment and credit that will allow a potential buyer to qualify for a loan,” Cleveland says. “While I believe it is important for a homebuyer to have some ‘skin in the game’ in the form of some sort of down payment, there are more programs becoming available now that require lower down payments,

which helps. Credit can also be a real challenge –whether a family is still recovering from the recession or someone is carrying student loans or credit card debt –many people are carrying debt that makes it difficult to qualify for a mortgage.”

Buyers of entry-level homes want upgraded features, but there is a great variety in what they are looking for. Each buyer is unique and the desires are more diverse than many earlier groups of buyers.

“Every one of them has got something different,” Herbert says. “Some want a nice kitchen. They want granite tops, stainless steel appliances, upgraded light fixtures. Some of them want hardwood floors throughout. Some of them want a big yard. They want it all sodded, and a fence for their dog.”

It also takes a different approach to marketing to reach many of these buyers. Herbert Homes spends most of its marketing budget on Internet marketing, including its website and social media. The company has found that to be more effective than traditional methods like newspaper advertising and open houses.

“You’ve got to think and operate differently now,” Herbert says. “It’s almost like you’re getting to 24-hours-a-day marketing.”

If you want to effectively market your company over the internet, be sure to read the “Tool Time: Digital Success” article on page 4.