(Updates with information on Lennar (NYSE:LEN) in the sixth paragraph and Zillow.com in the 10th paragraph.)

By Dawn Wotapka

Of DOW JONES NEWSWIRES

NEW YORK -(Dow Jones)- In the housing debacle's latest twist, some builders are competing with new homes - even of their own construction - that are being foreclosed on and resold for a song.

New home buyers haven't traditionally been big defaulters, and the shift is another blow for a sector crippled by the worst downturn in decades. To compete with the already bloated housing inventory, builders are cutting prices and offering freebies and financing specials, stressing weakened margins. Foreclosures, meanwhile, typically command below-market prices, grabbing attention from what few buyers remain in the marketplace.

"Mortgage foreclosures were never viewed as being competition for a new construction," said Lawrence Angelilli, senior vice president, finance for Centex Corp. (NYSE:CTX) (CTX), the nation's third-largest home builder by 2007 revenue, at a recent conference. "Now you do have this first-time phenomenon of massive foreclosures that are coming through on new construction."

Neither builders nor lenders track the foreclosure rate in active selling communities, and so the exact scope is unclear, according to multiple sources. John Burns, a California-based housing consultant, labeled it a "very significant problem."

To be sure, some say the trend isn't that widespread. But, with mounting foreclosures dumping even more homes - both new and existing - onto the market, it will likely grow. Credit Suisse estimates new foreclosures will peak at 1.69 million this year, with another 1.14 million expected in 2009.

Centex (NYSE:CTX) declined to comment for this article. In its earnings call Thursday, building behemoth Lennar Corp. (NYSE:LEN) (LEN) said no more than 20% of homes in current communities have entered the process, which ranges from the initial default to being resold as a foreclosure.

Hovnanian Enterprises Inc. (NYSE:HOV) (HOV), the sixth-largest builder, has seen "a couple of instances."

"We'd rather not have foreclosures at all, let alone at our communities," said Ara Hovnanian, president and chief executive. "It's just part of the marketplace at the moment, and our company, and others, are just dealing with it."

Industry watchers say new foreclosures are most prevalent in larger and multiphase projects, particularly in bubble markets including Las Vegas, Phoenix, California's Inland Empire and Florida. That's where companies massively overbuilt as speculators, taking advantage of loosened credit requirements, raced to buy and resell homes for a profit, only to be trapped in the housing crash. Non-owner occupied borrowers looking to flip fuel a lot of foreclosures, Centex's (NYSE:CTX) Angelilli said.

Generally, foreclosures sell for 20% below market price - which has already plummeted about half from 2006's levels in many hard hit areas, according to Daniel Oppenheim, a Credit Suisse analyst. In the first quarter, foreclosures accounted for nearly 30% of nationwide transactions, rising from slightly more than 2% in 2004, according to real estate Web site Zillow.com. As of March, that number was 72% in Stockton, Calif., and 45% in Vegas.

"In Las Vegas, if the property is priced well, especially with a foreclosure, there is a scramble," said Walter Czerkies, with RE/MAX Associates, who has shown "brand new homes."

Foreclosures, which aren't usually maintained, can drag down an entire neighborhood's value, hurting builders if construction - especially on the same floor plan - remains under way. Some builders say they have cut prices enough and customers like the new-home warranty, and so they are willing to wait until foreclosures clear.

Others respond by trimming prices further - even below cost - hurting the bottom line and fueling impairments, which have already passed $24 billion. In problematic areas, some developers have slowed and even paused construction until the market rebounds.

There are more divine solutions. "You hope and you pray that, as those foreclosure signs come up, that people start buying them as quickly as possible, (and) you're no longer competing," said Michael Kahn, senior managing director of Michael P. Kahn & Associates LLC, consultants to home builders and capital sources.

-By Dawn Wotapka, Dow Jones Newswires; 201-938-5248; dawn.wotapka@dowjones.com

    (END) Dow Jones Newswires   06-26-08 1633   Copyright (c) 2008 Dow Jones & Company, Inc.