Leadership

How Better-Than-Expected Results Became A New Win

Outperforming expectations now qualify as chest-pumping, back-flips-worthy triumphs. Compared-with-expectations measures – particularly on the price concessions and cancellations calculus that reveals net pace – amount to an accomplishment: Less-bad is the new good.

Leadership

How Better-Than-Expected Results Became A New Win

Outperforming expectations now qualify as chest-pumping, back-flips-worthy triumphs. Compared-with-expectations measures – particularly on the price concessions and cancellations calculus that reveals net pace – amount to an accomplishment: Less-bad is the new good.

March 24th, 2023
How Better-Than-Expected Results Became A New Win
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As market-rate housing's numbers fell faster and farther, a specter of deep price concessions and cancellation contagion overshadowed homebuilders last Fall. This was the backdrop as they budgeted early 2023 performance, planned tactics, and managed expectations.

They could hope for the best, but were obliged to plan for the worst.

In this context, better-than-expected results qualify as chest-pumping, back-flips-worthy triumphs. Compared-with-expectations measures – particularly on the price concessions and cancellations calculus that reveals net pace – amount to an accomplishment: Less-bad is the new good. We'll get back to this in a moment.

Suffice to say that the worst of their scenarios did not materialize. Far from it. Three factors – one mathematical, two psychological -- went their way, and they continue to support a cautiously constructive view of the business outlook for the smartest and strongest of homebuilding's higher volume enterprises this Spring and beyond, ... with a big caveat around volatility.

  • (1) a gust of good fortune from a helping mortgage interest rate retrace toward 6% from 7% in late November 2022,
  • (2) a wake-up call among buyers that dirt-cheap mortgages were now a thing of the past,
  • and (3), the clean slate of a new year to clarify "nice-to" vs. "have-to" priorities around 2023 being the year to make a move or not.

Add these three catalysts to already-evidenced powerful structural market motivators – the Millennial adult pig-in-a-python catch-up on household, income, and family formation, an already pronounced "underbuild" of housing of all types during the prior decade – particularly in places people have been and continue to be gravitating to, all further exacerbated by an anchoring phenomenon locking homeowners to houses they bought at historically low interest rates. Net, net, resales' loss has been new retail sales' gain.

Line up these generational positives head-to-head with an array of corresponding challenges – the Fed's dogged pursuit of normalized core inflation rates, a spreading cost-of-living crisis, a banking system crisis, an ever-menacing global political risk, not to mention health and natural hazard events, etc. – and you've got today's battle royale of headwinds versus tailwinds, with some nasty crosscurrents blasting through as well.

Complicated, tricky, volatile. That makes today's hard proof of performance more meaningful, guesses as to what will happen next less so, and, lastly, demonstration of a resilient slew of Plans B, C, and C practically a necessity.

In this context, KB Home strategic executives on Wednesday afternoon reported earnings for its fiscal Q1 2023, and added the latest available high-level strategic view of real-time market-rate single-family home sales.

In the 20-or-so member queue of publicly traded homebuilding firms reporting performance results and providing color on recent-week demand and business, KB Home follows Lennar, and offers important insights that both compare and contrast as real-time bellwethers of issues, challenges, and opportunities common, not only to public peers, but privately-owned regional and single-market homebuilders as well.

KB's high-level strategic differences from Lennar and a number of other multi-regional homebuilders focused primarily on entry-level buyers are its emphasis on built-to-order starts and work-in-process production flow, and its market concentration in some of the past year's more challenging geographies from an affordability standpoint. At a moment many builders have upped their ante on spec production to remove waiting time as a source of friction and worry, but KB's proven its execution and brand of customer focus more than met any challenges to bringing its home through to settlement.

For the time-being, the Wolfe Research team led by Truman Patterson notes, "it appears buyers are undeterred ... while pricing is relatively stabilizing."

An important note to acknowledge in both KB performance and accompanying remarks is that, like Lennar, its strategists took a "managing expectations" approach as they penciled plans and communicated guidance externally. Setting the bar low and then blowing through the forecast can help the publics, especially in a context of investors overweighting the importance of specific interest rate tolerances and their cause-effect impact on new home sales.

That said, the following passage in KB Home chairman, CEO and president Jeff Mezger's remarks setting the tone around the earnings release, and the strategic team's discussion in Q&A with investment research analysts Wednesday, set off the most intense vibration.

Our strategic goal continues to be a monthly absorption pace of between four and five net orders per community, which we think we will achieve for the second quarter, resulting in a projected range of between three-thousand and thirty-seven hundred net orders. At the midpoint, this will represent a net order decline of 14% year-over-year.

KB strategists even ventured to guide on full-year 2023 performance here.

Let's dive in and capture some strategic insights as they reflect the beginnings of a floor of confidence about how a company plans a self-determined course forward, the volatility and uncertainty notwithstanding.

Banking Disruption, So Far, A Positive

Jeff Mezger, Chairman, CEO, & President

We're watchful like everyone on this call to see how this plays out. We're not hearing anything right now on tighter lending standards. We're not hearing buyers say this banking crisis is really influencing my confidence. It's pretty quiet, but it's a headline that you're – you have to be watchful of and that if the regional banks got really stressed, it has to impact the economies where those banks are located. So we're watchful of it, but to date, there's no change in underwriting, liquidity is out there. Certainly the big banks we do business with are all open and doing their things. So far it's been good. If anything it helps drop mortgage rates down and it helps the consumer, but we have to wait and see how it plays out."

2nd Quarter Outlook

Jeff Mezger, Chairman, CEO, & President

As we shared in our prepared comments, February was very good for us. In fact, even with an elevated cancellation rate that's moderating, we were at four and a half a month or a community in the month of February and March has continued at similar levels."

Robert McGibney, Executive VP and COO

We were hitting the four and a half a month in February to increase sequentially each month of Q1. And while it's early in March, we're seeing even more positive results on the sales side than what we saw in February. So barring any kind of unforeseen surprise on that, we don't really see a reason that we won't continue on the path that we've been on which – that’s what gave us the confidence to guide the way we did."

Buy-Downs' Impact On Cost Of Sales

Robert McGibney, Executive VP and COO

We are using the mortgage programs. We've got both lock longer term loans or shorter term loans and in some cases buy the rates down. But I would say we're seeing that become less as the market's improving and we've adjusted pricing to get right in the communities where we don't have a lot of backlog that gets impacted. So we are using it, it's selective, it's not every community, it's not every customer, we use it where we need to drive the sales.
And another benefit that we're seeing is the cost of those programs is becoming less as well with rates coming down are typical and we offer a couple of different programs, but are typical is buying the rate down to five and seven, eight, and with rates coming down, the cost to do that has fallen along with the cost of the long-term lock. We can go out 270 days on a BTO sale to lock that. So the cost of both of those is coming down as well as the frequency of needing to use them with the market improvement and overall demand getting better here in the spring selling season."

Full-Year Outlook: Normalizing

Jeff Mezger, Chairman, CEO, & President

We're normalizing on the cadence. Our Q3 is typically down about 10% from Q2 and then Q4 is down 5% to 10% could be in parts because of the markets we're in are a little warmer climate and you get a lot of snow birds that come down in the winter and things like that. But in a normal year, we'll run 4, 5.5 in the second quarter and then it'll come down a little in the third quarter and come down a little in the fourth quarter and then over the year, you'll average between 4 and 5. So based on what we're seeing right now in a consumer behavior and we qualified it because there's a lot of unknowns out there, but based on what we're seeing, we think the markets are starting to normalize."

ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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