Homeownership's only-game-in-town positioning secured homebuilders a temporary reprieve. It came in the form of running room and agency to strike favorable operational balances in 2023. With their own concession switches and levers, homebuilders have maintained better-than-tolerable offsets between pace vs. price, spec vs. build-to-order, and gross margins vs. total volumes. With vigilant ongoing recalibration, a calm – if rigorous – path forward has given disciplined operators strong opportunities to equalize starts, sales, and closings in a relatively steady, almost predictable lock-step.

So, through the first three quarters of 2023, homebuilders – to the surprise of many of them – saw a modicum of momentum reignite. A by-product of a stagnating existing homes pool of inventory and a cresting demographics-based wave of household-, family-, employment-, and income-formation, the mojo took shape in a macro economy of resilient consumer purchase behavior and buoyant business hiring.

Broadly, stepped-up volume in speculative production starts for more price- and interest-rate-sensitive buyers in first-time and entry-level product tiers pulled through a lot of the overheads and paid the bills. At the other end of the product- and customer-segment spectrum, move-up and 55+ homebuyers cushioned profit margins from the worst of the thumps and bumps, and furthermore, signaled that that higher-for-longer interest rates and elevated prices would not flip their determination to buy into hesitancy.

Incentives, where they have been needed, worked, taking care of homebuilders' "math problem" of pricing-in buyers shooting for affordable-attainable new homes. And, in many cases, where they haven't been required, they stood at the ready.

In the first few weeks of October, however, the first signs of cracks in these delicate balances have begun to show up in choppier, more fitful and iffy selling conditions – coupled with typical seasonal slowing in activity – that may provide a preview of even trickier, more turbulent months leading into Spring selling 2024, a critical stretch of full-year 2024 business activity.

Particularly, the "math" side of the challenge – continuing to help pay young, less-well-heeled, first-time homebuyers' way into new homeownership through mortgage buy-down programs – gets more challenging, more expensive, and more touch-and-go with every volatile week for interest rates, inflation effects, and mixed-signals macro-economic trends.

No soul can have failed by now to notice that home mortgage contract rates are the highest they've been for a generation. The flow-on effects of these rates have radiated intensifying payment-power pain to buyers and lock-in paralysis among sellers, more or less grinding the nation's existing-home sales engine down to Great Financial Crisis levels.

The 9- or 10-month window of reprieve dating back to December 2022 through September – giving would-be homebuyers an "only game in town" option to land a quality, never-lived-in home within reach of their household earnings capability – effectively bought homebuilders time to seize opportunity to future-proof themselves in two essential ways:

(1) Ready, refine, release, and re-calibrate a full repertoire of home sales incentives, concessions, upgrades, buy-downs, and discounts as absorption pace and closing "cadencers," both to secure backlog orders and to push forward each actively-selling community's order-flow horizon. Against a backdrop of a listless existing home sales marketplace, competence in this skillset gave homebuilding operators cause-and-effect agency in their efforts to sustain monthly absorption levels to drive profitable new home production, community by community.

(2) Capture back as many direct input and overhead costs as possible as a way to offset the added cost of sales of the array of incentive programs. Some operators have come within 30-days or so of having closed a 120-day gap in construction cycle times during peak "supply-chain-meltdown" months, giving them added cushion in their margins to absorb even heavier cost on the incentive side.

Having 10-plus months of runway into what looks like a bumpier stretch ahead, operators sought to keep push-and-pull balances on the lower-price tier entry-level and first-time buyer customer segment spectrum by standardizing plans, upping spec levels for faster-close and move-in buy-cycles, and working to price-in swaths of buyers with an assortment of mortgage buy-downs, ranging in duration.

At the same time, operators with diversified product lines have pushed up pricing, product value offerings, and profitability on build-to-order homes and communities for less price- and interest-rate-sensitive move-up, 55+. They've added emphasis on those orders in their backlogs as a firewall against any further deterioration among more constrained first-time buyers.

Homebuilders like PulteGroup, for whom we cast out our quarterly earnings cycle antenna in an effort to detect signs of whether the market is tipping into one of greater risk and challenge for homebuilders, and now Taylor Morrison have added color on tougher-sledding during the early weeks of Q4 2023 as a result spiraling interest rates and a high-bar of asking prices start to winnow out the stream of demand.

The issue most operators are so keen to grasp right now is whether to compare recent pull-backs in order levels to sequential – better than seasonal trends – of the first three quarters of 2023. Or, as they're choosing to do, compare the flare-ups of choppiness and air pockets to more typically normal, pre-pandemic pace, price, and profitability benchmarks.

We'll let you decided whether to interpret remarks about whether the first few weeks of October signal a homebuyer demand market that's in its early stages of capitulation to the painful weight of high and higher-for-longer interest rates, or whether another resilient rebound lies ahead.

Here's a select few grabs from the transcript of yesterday's Taylor Morrison earnings call with investment research analysts. Should they be taken at face value, or are they nuanced to provide cover for already-evident deterioration? It's probably too soon to tell. You decide.

The High-Level

Sheryl Palmer, Chairman and CEO, Taylor Morrison

The rapid re-acceleration in interest rates in September has once again injected some hesitation into the market and drove a moderation in sales momentum that has continued into October alongside typical seasonal slowing."

... The third quarter was healthy despite the headwinds from last year’s slower activity and the interest rate pressure that unfolded during the quarter. As we head into year end, there are many factors at play complicating what is always a high-volume push for the industry to deliver homes to customers and ready inventory for the coming spring selling season."

The sharp spike in interest rates over the last two months has once again pushed affordability to unsustainable levels for many buyers, especially at the entry-level and is weighing on buyer confidence and urgency even among some with the financial ability to move forward.

... as we have moved into October, as I have said, we are still – from a historical perspective, from a seasonal perspective – looking really nice and we are seeing good traffic and sales. It’s just I can feel the difference from what we saw earlier in the summer."

Incentives Working Harder

Sheryl Palmer, Chairman and CEO, Taylor Morrison

What I was trying to get across in our prepared remarks was the power of our incentives, and how necessary they are when you compare to 2021 rates of about 3%, and what we are seeing in today’s market of 8%.

So if I run through the programs quickly for you – without going into too much detail – about 94% of our closings in the quarter had some sort of discount points paid by either the buyer or seller. That number is not really any different than what you would have seen historically, maybe somewhat influenced by the percentage of cash because really everyone that’s got a mortgage, we are helping in some way and on those discount points the average was probably just under about 2.5%.

And then if you go to the temp buy-downs where the costs are calculated based on the loan amount, that’s been running about 2.25% for a two-one buy-down, those costs are obviously paid by the seller and that was only about 13% of our third quarter closings that used a temporary buy-down.

And then it’s important to see the stacked effect is our forward commitments, which include our Buy-Build-Secure program for extended-lock programs. This is where we purchase a forward tranche of money on a specific date. We are doing that potentially daily, weekly, depending on the need and that allows us to offer an interest rate below market.

We have to buy those funds before the customer is in contract, and that way, honestly, the dollars are not included in our seller contribution limitations. But when we look across the portfolio, that was only 18% of our Q3 total closings.

So when you put that against the margin, it’s actually very small – less than 1% on forward commitments specifically across the portfolio for Q3. Interestingly as well, the average interest rate for our forward commitments in Q3 was just about 5.5%.

Unpacking Buyer Hesitancy: Math Or Mental?

Sheryl Palmer, Chairman and CEO, Taylor Morrison

There’s a lot of attention around what’s happened to interest rates, the way the media is portraying that – and honestly – the impacts it has on true affordability when you look at the difference of where we were a year or two ago.

I don’t think it’s specifically that they feel that prices are going to drop. Actually, at some level it’s the opposite. That's because inventory is so tight that I don’t think they are expecting that we are going to see a reduction in pricing overall.

It’s as much around just general affordability for that first- time buyer, and as I said in my prepared remarks, though, it’s a very deep pull. So we are seeing the traffic, we are seeing demand. It’s just working with customers to get them qualified.

And then when you look at the other consumers, I think, they are being appropriately diligent in understanding what choices are and what’s happening. When I look at our October trends, you know, we are still up. I expect we will still be up considerably year-over-year. But to say that it’s the same that we saw in early summer, when rates were in the mid-6s, versus 8. That would be unfair."

Tougher To Qualify At Lower Price Tiers?

Sheryl Palmer, Chairman and CEO, Taylor Morrison

What I really want people to take away is on that first-time buyer pool, it’s deeper. It just takes – it used to take a 5:1 to get a conversion. In today’s environment, it’s [more like] 7:1 or 8:1. Once again, that’s going to depend on community and market.

But we have the tools that are helping our buyers, even in today’s environment kind of withstand the challenges that have been brought by interest rates and pricing, and just kind of the overall inflationary environment. But it just takes a few more, certainly on that first-time buyer."

Outlook In 'Higher-For-Longer' 2024

Sheryl Palmer, Chairman and CEO, Taylor Morrison

I think that will be always weighing on the minds of the consumer today along with some of the other macro factors that we are seeing and the consumer is being faced with. But I get grounded very quickly on the lack of supply that we have and the needs of consumers to get shelter.

So as I look forward, once again, assuming no significant shifts in what we are seeing in today’s environment this kind of rate for longer, we all have to be prepared for that until the Fed gives some clarity around next moves around MBS, I think, that’s going to continue to weigh on folks. But when I look at next year, I think, across the industry, and certainly, for Taylor Morrison, we expect to see movement upwards on both sales and closings – sales starts and closings."

Seeing A Mix-Shift As Rates Go Up?

Sheryl Palmer, Chairman and CEO, Taylor Morrison

Our strongest pace for the quarter was entry-level and then followed by move-up. Active adult would have been third up and that would be expected in Q3 when generally we are in kind of the summer season before we move into the shoulder selling season.

So, as I said, [we have] a deep, deep pool of first-time buyers. So we are seeing the traffic and we are getting the sales. We just have to put the right programs forth to make sure we can get them qualified."