'Lousy' housing inventory on the resale side is a boon for Toll Brothers, CEO says

Toll Brothers (TOL) CEO Douglas Yearley wasn’t shy to call out the state of the country’s housing stock — a key reason that fueled the homebuilder’s latest busy quarter.

“What is sitting on the market is the old, tired inventory, which actually makes it even better for us," Yearley said on the company's earnings call Wednesday after blowing past quarterly orders expectations and raising its sales guidance late Tuesday. "Because not only is the resale market really tight, but the quality of what's sitting on the resale market is lousy.”

Yearley's comments also come as government data on Wednesday showed that new home sales rose higher than expectations in July — a reminder that new construction remains a bright spot in today's odd housing market.

“The market for new homes is solid, and we are well positioned with the right strategy in place to take advantage of it,” Yearly said on the call with analysts.

The current backdrop has favored builders to expand spec homes, build smaller homes, lower prices regionally to seek out buyers, and re-polish their outlook for the year. Toll Brothers is no exception.

“We attribute the solid demand for new homes, at least in part, to the well-publicized shortage of existing homes for sale,” Yearley said. “Existing homeowners are clearly reluctant to give up their low-rate mortgages. And while rising rates remain a challenge for the overall industry, they further cement the lock-in effect that has kept the resell inventory at historically low levels.”

More spec homes

The combination of steady demand and a focused spec home strategy helped the builder to clock in “another terrific” period during its fiscal third quarter. Toll, which touts itself as the “affordable luxury” builder, defines spec as any home without a buyer that has a foundation poured.

Toll Brothers delivered 2,524 homes in the third quarter, up 5% from the same period last year. Sales revenues increased 19% year over year to $2.7 billion.

Demand for spec homes made up about 40% of the builder’s home orders in the quarter, and the builder expects the trend to hold ground in the future. Additionally, specs were 28% of deliveries in the third quarter, while 2,400 specs are still under construction.

The builder also sells specs at various stages of construction with a preference to sell before completion, so buyers can personalize their homes.

But Toll isn’t the only builder pulling these moves. Competitor PulteGroup (PHM) said in its second quarter earnings that the homebuilder was able to meet stronger demand with available spec inventory, allowing it to slightly exceed its closing guidance.

“Along with the balance between our build-to-order and spec production, we are appropriately diversified across all the buyer groups consistent with our long-term goal of having 40% first-time, 35% move-up, and 25% active adult,” Ryan Marshall, president and CEO at PulteGroup, said on the earnings call with analysts.

“Why is this important? The different financial profiles associated with each buyer group can mean different responses to changing market dynamics, such as today's rising rate environment, which may hinder first-time buyers, but be less of a headwind among active adult consumers,” Marshall added.

With mortgage rates hovering around 7%, home affordability continues to weaken. Builders remain eager to offer prospective homebuyers incentives — including more affordable rate buydowns.

“It does work well as a lead marketing headline for the spec inventory that can deliver over a four-month period of time. So we may advertise for spec inventory that will take a 7.5% rate down to 5.5%,” Yearley said.

Looking forward, the luxury homebuilder expects to deliver between 9,500 and 9,600 homes, an increase of about 200 homes at the midpoint of its previous guidance. Additionally, the builder increased its guidance for the full-year average delivered price to between $1.05 million and $1.15 million.

“Demographic and migration trends continue to provide long-term support for the industry with millennials forming families and buying their first home later in life when they have higher incomes and accumulated wealth,” Yearley said. “Baby boomers who are either retiring or planning for it are also moving as they adjust to their new lifestyles. There also appears to be an increase in generational wealth transfer with parents helping their kids buy homes.”

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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.

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