I have had several conversations with builders recently about the trade-offs between pricing to margin and targeting velocity. While one could argue it is a mix of both or a matter of business preference, it is worth exploring how this choice has evolved. While it is always important to be informed by history, it is just as important to think about what is different.

The Evolution from Margin to Velocity

Before the Great Financial Crisis (GFC), there was a pervasive belief among many homebuilding consultants that builders should price to margin, and quite a few private builders still adhere to that approach. As I have noted, public builders have by and large moved away from targeting margins to set home pricing and instead target sales velocity to set pricing.

In 2013, public builders were operating at roughly 20 sales per project per year; by 2019, they were over 40. During the pandemic, they well exceeded that number even while metering sales, and recently several have noted they have reduced their targets because they are unsure there is sufficient demand to hit their optimum velocity. But they are still targeting a minimum velocity.

How the Business Environment Has Changed

In thinking about these trade-offs, let us examine how the evolution of the business might impact that decision. In the past (pre-GFC), it was much easier to be a merchant builder.

There were many developers providing lots, often on a rolling takedown basis. Builders mostly built pre-sales, so their balance sheets consisted primarily of option deposits and work-in-progress (WIP). Cycle times were three to four months. Land was, if not plentiful, readily available, and processing times for new projects were much faster than today. This is not to say there were not builders piling up lots on their balance sheets, but it was possible to run a land-light, margin-oriented company in many parts of the country.

Because private builders' balance sheets were liquid (pre-sold WIP converts to cash very quickly), at least if they optioned lots, banks were much more aggressive in their lending than they are today (higher loan-to-value ratios, loan-to-cost ratios, and company leverage covenants). Higher leverage meant that very little equity was necessary to run a private builder, comparatively speaking.

With a lot of debt and little equity, the cost of capital was much lower than in today's lower-leverage environment. What's more, period costs tend to be much higher today than in the past.

Today's Market Reality

Today, timeframes to approve and open projects are long and uncertain. Outside of Texas, there are not many places where you could survive as a builder relying on finished lots with rolling takedowns. Leverage from banks is much lower, alternative capital is expensive, and your competitors — the public builders — are committed to velocity as the key to lower selling, general, and administrative expenses (SG&A) and better net margins.

You can believe that this is a recipe for a race to the bottom on price, or you can view it as prudent management of capital. But it does not matter — it is still your competition setting the market price unless you have managed to achieve a dominant local market share.

The Fundamental Difference Between Approaches

Let us also consider what pricing to margin means and its risks. Pricing to margin is inherently not a market-based approach to pricing, while pricing to velocity is a direct response to and engagement with the market. Margin analysis is great for making investment decisions, refining product, etc. But it is not material to pricing homes after the investment decision has been made.

Buyers decide the market price—we do not.

The Risks of Ignoring Market Signals

If you are not meeting the market on pricing, is that because you can predict when the market will accept your pricing? While I have confidence in market projections over longer time horizons — we are not going to build enough single-family homes, for example — I have no idea whether the home-selling market will be better or worse in the next six to twelve months. And I do not believe anyone else does either.

Think about all the things most of us have gotten wrong just in the last few years:

• "The rate spike might sink us." Except it did not.
• "Rates will begin to fall." Except they have not.
• "Uncertainty will improve after the election." How is that working out?
• "Tariffs will cause a recession." Not yet anyway, although it could be coming.

Long-term trends of demographics, housing supply, etc., are things we can have confidence in. Short-term consumer behavior and economic fluctuations are not.

If you are holding price on units that are not selling:

• Do you have a crystal ball to know whether the market will improve and when?
• What will the period costs add up to while you wait?
• What is the opportunity cost of not recycling your cash?
• What will happen to your subcontractor pricing and availability?
• What about company morale? Nothing worries people more than a lack of activity.
• If things get worse, are you now chasing the price down and selling for even less than you could have initially? Like it or not, unless a slowdown is remarkably quick, he who cuts first cuts least.

Strategic vs. Tactical Thinking

While how to manage the trade-offs between price and velocity is unique to every builder and market, overall, it is best to think about strategic decisions as long-term and short-term decisions as tactical. Which means meet the market.

To use an analogy, managing a project's sales velocity is a lot like flying a plane. Stall speed should be avoided at all costs. And remember, houses should NEVER have a birthday.