While many homebuilders, such as D.R. Horton and Tri Pointe Homes, significantly reduced the number of new home starts over the last quarter amid sluggish homebuyer demand, Smith Douglas Homes Corp. is taking a different approach, akin to that of Lennar.

Pace over price. 

The builder’s strategy reflects a commitment to affordability and serving the strained entry-level buyer segment. This blueprint has its pitfalls — the average home sale price is down, incentives are up, and margins are thinner. However, CEO and President Greg Bennett reaffirmed his company’s commitment to this philosophy on a November 5 Q3 earnings call. 

We continue to push on incentives into year-end, really in an effort to keep that pace over price philosophy. Obviously, we're really deliberate about keeping that pace. It's really important for our operating philosophy. We make more, we lose less at full capacity.”

Smith Douglas’s average sales price of about $333,000, down 2.6% year-over-year due to higher discounts and shifts in the geographic mix, is among the lowest offered by public builders. 

In conjunction with its price-over-pace strategy, SDHC is also aggressively pursuing geographic expansion and greater market share within the confines of a measured, focused approach. 

Incentives Could Continue to Increase

The company began offering a 3.99% FHA 5/1 ARM with no closing costs on many homes, and recently introduced a 3.5% fixed-rate on some spec homes that sat unsold for an extended period of time. 

We've been able to solve the rate issue for some time now, but it does seem like it's just becoming a little more difficult to get buyers across the finish line,” Russell Devendorf, Executive Vice President and CFO, said. 

SDHC executives said they will offer more incentives in the months ahead if that is what it takes to drive volume. However, the builder is also working to reduce the balance of specs from the current 50% rate closer to the historical average of 30%, as spec homes typically require more incentives. 

We are focused on preselling. It's really the environment that's pushing us more to a little spec heavy,” Devendorf said. “You're starting to see spec levels come down from other builders, which is also a factor impacting us as well. I think that will continue to shift back in our favor over time.”

Trevor Allinson of Wolfe Research anticipates that incentives could increase in the near-term future, as SDHC emphasises pace. 

With September and October absorptions running at a 2.0 monthly pace, we would not be surprised to see SDHC continue increasing incentives to drive higher volumes to avoid compounding carry costs on a land bank that potentially becomes more disadvantaged should land pricing eventually inflect lower,” Allinson wrote. 

Despite these headwinds, SDHC has tripled its controlled lots over the past 18 months and anticipates increasing the community count by 10 to 20% over the next year. The company is relying on its rapid 54-day cycle time, which stands out in an industry where 90 to 120 days is the norm, to deliver inventory quickly. 

The emphasis on volume is a core principle that benefits velocity, Bennett said during a Q2 earnings call in August.

Our trades know they’re getting a commitment of starts, and that allows us to be more reliable in our assembly process."

Expanding into New Markets With Purpose

SDHC currently operates in Texas, Georgia, Alabama, Tennessee, and the Carolinas, and announced earlier this year that it is entering the Dallas-Fort Worth and Gulf Coast Alabama markets. 

The builder is expanding quickly, but with a clear strategy.

We want to make sure that we enter markets where we can gain scale. And for us, scale is — we operate in an R-team philosophy and geographic pods. So each pod of our team has 200 closings. And so, for us, we'd like to, at a minimum, have 400 closings per division. Certainly, in some divisions, we're going to have in excess of that, in some of the larger markets like in Atlanta, Houston, and Dallas. But at a minimum, we're looking to do at least 2 full R-teams,” Devendorf explained. 

This vision guides SDHC’s growth path and shapes the markets where the builder is looking to scale up.

We've been prioritizing or really trying to scale up in those markets where we have not yet hit that escape velocity, I'll call it, or that scale. You can look at Charlotte, the Carolinas, Nashville – those are some of the areas that we've started to focus,” Devendorf said. 

Bennett said there are widespread issues with permitting and obtaining final plan approval to start projects. However, particular areas tend to present a more difficult entitlements and permitting process, which may inform which submarkets to prioritize going forward.

I wouldn't say it's in any market more so than another, but we do see it less prevalent in the areas that may be truly outside of the metros that are a little hungry for having some stimulation from housing. In more of the central metro markets, we're still seeing a lot of delays,” Bennet said. 

Key Takeaways

Smith Douglas Homes Corp. isn’t immune to the broader macroeconomic trends impacting homebuilding. Despite its pace over price strategy, home closings decreased 3% year-over-year, and revenue declined by 6%. 

The company’s gross profit margin fell 550 basis points annually to 21%, a warning sign that is symptomatic of increased incentives and a slight decrease in average sales price. 

However, SDHC’s commitment to maintaining pace and leveraging incentives to increase conversions is bolstering its efforts to serve its entry-level buyers while also maintaining a healthy margin. 

This commitment also aids the builder’s expansion efforts into new markets and emphasis on gaining market share. While many competitors retreat on scale and sacrifice market share in favor of higher margins, SDHC’s latest quarterly earnings reveal a builder that is leveraging its rapid cycle time and focused expansion strategy to follow a different path.