Leading U.S. home builders appear to have adopted one of two strategies to endure a rapidly deteriorating housing market, based on differing bets on just how long the slump will last and how bad it will get.

In one camp — which includes Hovnanian, Lennar and D.R. Horton — are companies that will prop up home sales by cutting prices.

In the other — including Toll Brothers, KB Home and Ryland — the companies plan to hold prices steady but sell fewer homes, to protect operating margins.
Thrivent analyst Keith Gangl said the price-keepers reflect an optimism that things will improve soon, while price-cutters take a more pessimistic view.

"It all depends on how comfortable you are with the outlook," Gangl said.

Analysts prefer that builders use price reductions as a last resort and warn that they could suffer the same fate as the car industry.

"You don’t want your customers to get used to aggressive incentives," J.P. Morgan analyst Michael Rehaut said. "Obviously, the auto industry has continued to find itself in that position and it’s not a good position to be in."

On Wednesday, Hovnanian Enterprises Inc., which builds high-end homes, said orders in its quarter to July 31 fell 26 percent from a year earlier. While the year-over-year results were eye-catching, the fall was not as bad as expected and the stock rose 6 percent the next day.

The company discounted prices in weaker markets — such as southeast Florida, which went from one of last year’s hottest markets to what Chief Executive Ara Hovnanian called either "the worst market in the country" or one of the worst.

Hovnanian was able to keep its orders up because it increased the number of developments it built to 436. It expects to end its fiscal year on October 31, with 440 communities, 20 percent more than last year.

"It is clear that the significant decline in our pace of net contracts per community has been partially offset by our growth in communities, which has kept our absolute number of sales from falling more substantially," CEO Hovnanian said in a conference call with analysts.

But net contracts per community stood at 7.7, down almost 40 percent from a year earlier and the lowest in 10 years.
D.R. Horton Inc. and Lennar Corp., who report results in the upcoming months, have followed the price-cutting playbook closely.

On Friday, Lennar warned that its use of incentives was one of the reasons that earnings for the most recent quarter would fall short of its prior forecast. But it also said orders declined only 5 percent for the same reason.

"Horton and Lennar are two of the most tenured management teams, said UBS analyst Margaret Whelan. "You would think they’d be the best operators in a correction like this. It’s the worst strategy. They’re going to have the most margin erosion because of that."

Raymond James analyst Rick Murray said he anticipates price cuts and incentives would erode Lennar’s gross margins to 18.9 percent from 25 percent last year.

"But if the market gets much worse in ’07 and ’08, Horton is going to look like the smartest guy in the room," Whelan said.

In the other camp are luxury home builder Toll Brothers Inc., KB Home and Ryland Group Inc., which have all seen orders tumble but have tried to maintain their prices.

On Wednesday, KB cut its forecast and said orders were down 43 percent. Neither KB nor Ryland has yet reported their latest quarter.

Though they resisted cutting price tags, these builders are giving buyers more for their money. Toll offers "incentives" such as better countertops or a break on the buyer’s mortgage. Although gross margins declined 410 basis points, they still topped 29 percent, analysts said.

However, Toll issued a forecast that implied new orders will start to significantly improve over the next two quarter.
But Raymond James’ Murray had his doubts, given that Toll’s orders fell 48 percent in the most recent quarter.

"We believe a rebound in fundamentals is not in the foreseeable future," he said.