Toll Brothers predicts a decline in mortgage rates will coincide with the spring selling season
Rising mortgage rates did little to scare off Toll Brothers’ customers, but the homebuilder is happy rates are softening.
"October was stronger than expected, given the rise in mortgage rates and we were encouraged that we did not have to increase incentives to drive sales in that month," CEO Doug Yearley said on the company’s fourth quarter earnings call Wednesday.
"With inflation easing over the past few quarters, we believe rates may drop further and the timing of the rate decline is setting up nicely for the upcoming spring selling season," Yearley added.
Rates neared 8% during October, spooking some budget-conscious buyers from the newly built homes market. The 30-year fixed mortgage rate hit 7.79% in the last week of that month, according to Freddie Mac. Rates have retreated since then, dropping more than a half point since the end of October.
Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?
Spec homes vs. build-to-order
The strategy to focus on speculative homes — a home without a specific buyer in mind — is paying off.
"The return on equity from the spec homes is a little higher than the return on equity of the build-to-order homes," Martin Connor, chief financial officer of Toll Brothers, said on the call.
One key reason is the pace to build and deliver is lower by about two months. The current housing backdrop has also allowed the homebuilder to gain market share among more cash-strapped buyers because its spec homes sell about $200,000 less than build-to-order ones, reflecting the lower lot premium and fewer upgrades.
In the fourth quarter, the luxury homebuilder delivered 2,755 homes and generated $2.95 billion in home sales revenue, $211 million above the midpoint of their guidance. Net orders slipped about 20% from fiscal fourth quarter to first quarter due to slower demand during the holiday months of November and December. Still, spec homes represented about 42% of its orders and 33% of deliveries.
Going forward, the builder expects specs to make up 35% of its fiscal 2024 deliveries. The remaining 65% of deliveries are either in its backlog, which totaled nearly 6,600 homes and $6.95 billion at fiscal year-end, or are build-to-order homes already sold or will be sold in the first quarter.
"We sell our specs at various stages of construction, which allows many of our buyers the opportunity to still personalize their homes with finishes that match their tastes. Specs allow us to buy down mortgage rates, and we also benefit from a faster, more efficient construction schedule," Yearley said.
Due to normal seasonal patterns, the first quarter deliveries are expected to be the low point of the fiscal year, with deliveries for the full fiscal year weighted in the second half.
Lower prices, new mix
Toll Brothers is also working to keep prices lower for potential buyers.
Read more: How to buy a house in 2023
During the fourth quarter, the homebuilder signed 2,038 net contracts at an average price of $989,000. While the volume of units is up 72% compared to the same period last year, the average price is down 11% and essentially flat over the prior three quarters, Yearley noted.
The reason for the downward pricing trend? A new pricing mix strategy. The homebuilder actually raised the average net price after incentives by $16,000 in the quarter.
"Remember that our mix shifts and lower [average sales prices] should not be a surprise," Yearley said. "It means our strategy of broadening our product offerings to include lower price points and capture greater market share and growth opportunities is working."
Through this strategy, the company plans to grow its footprint. Its community count is set to expand by about 10% in 2024, targeting 410 operating communities at year-end.
Looking forward, the luxury homebuilder expects to deliver between 1,800 to 1,900 units in the first quarter of 2024, while ending the year with 9,850 to 10,350 units, with an average price of between $985,000 and $1.5 million.
However, adjusted gross margin in the first quarter of fiscal 2024 is projected to be 28% and for the full year to be approximately 27.9%.
"The slight decline in our projected gross margin for Q1 from Q4 reflects the impact of the slower sales environment in the second half of fiscal '22 and the first quarter of fiscal '23," Connor said, "as more sales from that period will be delivering in Q1 than delivered in Q4."
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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.