Land Prices Hit the Brakes

Land Prices Hit the Brakes
Slowdown of New-Home Sales Curbs Growth of Lot Prices

By Kris Hudson
Wall Street Journal

Updated Oct. 29, 2013 8:31 p.m. ET

The slowdown in sales of newly built homes since last summer has sapped momentum from the land market, as home builders are starting to balk at paying increasingly lofty prices for lots.

The trend stands to slow the rise of new-home prices, which have increased since 2011 and now are at 2008 levels, an average of more than $300,000 this year, according to the U.S. Census Bureau. Land typically accounts for up to 40% of the cost to build a home.

Since the housing market began recovering in 2011, investors have been bidding up the price of finished lots, which are home pads outfitted with infrastructure such as utilities and sewer pipes and thus ready for construction. But with new-home sales and prices cooling, some builders are renegotiating land buys to get lower prices or even walking away from deals.

Nationally, 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, according to a survey of land buyers and sellers in 55 U.S. markets conducted by housing-research and advisory firm Zelman & Associates.

“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.”

Lot prices have been volatile since the downturn hit. In early 2009, prices for finished lots were about 55% to 60% lower than their 2006 peak, according to Zelman & Associates estimates.

Lot prices began rebounding in late 2011 and posted their biggest gains since then in the first half of this year, fueled by robust demand for homes and a shortage of lots in most markets. In an extreme example, finished lots in the Sacramento suburb of Roseville, Calif., that sold for an average of $120,000 each in early 2012 had jumped to about $220,000 by this year’s first half, according to land brokerage Land Advisors Organization.

The land-price increases went hand-in-hand with the rising prices of new homes. The average price of a new home in the U.S. reached an all-time high of $337,000 in April, census data show. During the housing crisis, the average dipped as low as $245,000 in January 2009.

The home market took a downward turn last summer, as buyers were spooked by double-digit percentage increases in new-home prices and a 1 percentage-point increase in interest rates between May and September.

With demand for new homes weakening, builders began re-examining what they were willing to pay for land. Some buyers now are asking sellers for lower prices on land they already have committed to buy, a practice known as “retrading.” Others are canceling deals before they are required to make nonrefundable deposits but after they have spent thousands of dollars assessing the land’s potential.

As a result, land prices have lost some of their upward momentum, and in a few markets they are declining. In Roseville, lot prices have retreated by 20% to 25% since peaking early this year, according to Land Advisors.

“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. “There has been some retrading.”

Neil Morris is among the sellers who were left at the altar. National builder Lennar Corp. had been under contract for a year to buy from an investment group he represents a 50-acre parcel near Durham, N.C., where it planned to construct 250 town homes. The price: $17,000 per lot, totaling $4.25 million.

This month, Lennar walked away, telling Mr. Morris it had decided the development costs were too high to be covered by what Lennar figured it could charge for the town homes, he recalled. A Lennar representative declined to comment. “It’s a little frustrating,” Mr. Morris says.

Meritage, based in Scottsdale, Ariz., canceled two land purchases in the Phoenix area in August and September after it spent more than $10,000 to study building on each. The conclusion: The parcels’ prices were too high absent larger gains in home prices. “We just didn’t see the home-price appreciation in those markets,” says Michael IlesCremieux, a regional vice president of land for Meritage.