U.S. home builders, struggling under sinking demand and a credit crisis, now face a fresh obstacle: competition from a flood of homes in foreclosure.
Grappling with the worst U.S. housing market downturn since the Great Depression, home builders have curbed their building activities. They've also been slicing through their inventories of unsold homes by slashing prices even at the expense of profits, all to pay off their own debt and keep afloat.
Now, in addition to higher mortgage rates, skittish buyers and competition from other builders, they face a rising number of homes whose owners are unable to sustain their mortgage payments.
"In some regions, the supply coming to the market from home builders is now smaller than the supply coming from foreclosures," Deutsche Bank senior economist Torsten Slok said.
The situation in the housing market remains gloomy, and the home builders seem to be waiting for the foreclosure "tsunami" to pass, Slok said.
But many say it may get worse as delinquency risk is likely to rise over the next 18 months, according to First American CoreLogic, which tracks and analyzes real estate data.
"This is the central issue for housing in 2008 and maybe for 2009 as well," said Buck Horne, Raymond James analyst.
The rate of mortgages with payments more than 90 days late rose to 4 percent of all U.S. residential mortgages in April, up from 2.1 percent last year, according to First American CoreLogic. The rate of loans in the process of foreclosure rose to 0.7 percent from 0.4 percent in April 2007.
The number of homes that have been repossessed rose to 660,000 in April, according to First American CoreLogic. Based on April's figures from the National Association of Realtors on existing homes for sale, 14.5 percent, or one in seven homes for sale in April were the result of a foreclosure in which the home was repossessed by a lenders.
Foreclosures are highest in areas such as Florida, California and Nevada, where builders rushed to attract first-time home buyers when the market was hot.
"A lot of the foreclosures are relatively new houses that people bought from home builders way out in the middle of nowhere where they couldn't afford them," JMP Securities analyst Jim Wilson said.
Foreclosures tend to sell at deep discounts, driving down prices of competing homes and forcing builders to cut prices and offer more incentives. In turn, builders are forced to reduce the value of the land they hold as assets on their books. That forces them to take charges against their earnings and may put their loans in jeopardy.
Rising foreclosures also make new mortgages more expensive and harder to obtain, as banks find it difficult to assess who is at risk of default, Raymond James' Horne said.
"Lastly, the number of foreclosures just destroys consumer confidence—particularly in neighborhoods where even borrowers who are current on their houses are seeing home value drop 30 and 40 percent," Horne said.
Because the foreclosure rate is highest on mortgages granted to first-time buyers, nearly all home builders have been affected, analysts said.
However, those who catered more to first-time buyers—such as D.R.Horton, Centex, KB Homeand Beazer Homes USA—are more susceptible to rising foreclosure rates.
Donald Tomnitz, chief executive of D.R. Horton, the largest U.S. home builder, said recently that foreclosures had been impacting certain markets such as Las Vegas but were not yet affecting the market as a whole.
"As we look forward to the second half of calendar year '08 and all of ... '09, I think foreclosures are definitely going have a negative impact on the new-home market, and that's the way we are positioning the company," Tomnitz said.
Drowning in Supply
Supply is a main obstacle preventing the U.S. housing market from recovering from its two-year slump.
Centex Chief Executive Timothy Eller said foreclosures hitting the existing home market will probably get worse and pressure prices. To head off the glut, Centex has been selling its inventory of unsold homes at the expense of profits.
"Our teams in the field worked hard to accelerate sales and reduce inventory levels ahead of foreclosures," he said.
Mortgage strategists at Lehman Brothers expect 1.2 million foreclosed single-family homes to return to the market this year, representing 30 percent of existing home sales.