Cut the Price by 20% and They Will Come: Homebuilder Meritage Explains New Era after Sales Orders Collapse by 46%

Cutting construction costs by “aggressively rebidding” projects, and “walking away” from land deals: executives in their own words.

By Wolf Richter for WOLF STREET.

Meritage Homes, which specializes in building entry-level houses, reported Q4 earnings on Thursday. In terms of revenues and income, they’ve been working through their backlog.

But sales order volume collapsed by 46% in Q4 year-over-year, to just 1,808 houses. Sales order volume in terms of dollars collapsed by 52%, to $704 million.

Orders got hammered by “weaker overall demand,” they said during the conference call, and because customers cancelled 39% of their contracts, up from a cancellation rate of 12% in Q4 2021.

And there was the dramatic plunge in the average sales price (ASP) of the houses that were ordered in Q4. The ASP for orders dropped by “20%” or “almost 20%” from the peak, as they phrased it (actually -19%), from $480,000 at in Q2 to $389,000 in Q4.

These sales orders aren’t included in the revenues yet – only closed sales are included. But those that don’t get canceled will show up in revenues when the houses are delivered and the sales close.

According to the executives on the conference call, this drop in the average sales price (ASP) for orders wasn’t due to a change in the mix of homes sold, such as more low-end homes in the sales order mix, but due to actual price cuts, mortgage rate locks, and mortgage-rate buydowns in order to revive sales order volume.

Cutting prices 20% revives sales order volume.

“Our position is that we’re an affordable builder,” CEO Phillippe Lord said during the earnings call (transcript via Seeking Alpha). “We have to get to a payment that makes sense for our customers.”

“We have taken additional actions to get back on our [sales] target, including lowering prices and utilizing a full range of incentives such as mortgage rate locks and rate buydowns, until we find the market clearing point to move our inventory and get back to our target sales pace,” Lord said.

CFO Hilla Sferruzza said: “We’re comfortable at our current pricing structure. We’re down almost 20% from the peak and we’re able to sell at an acceptable pace. So we don’t feel like we need to move it any further at this time, although we’re constantly adjusting with market conditions.”

January sales order volume increased from Q4 and showed that the 20% cut in ASP worked in perking up sales, they said. The company gave guidance for Q1 based on the sales in January, but withheld guidance for the rest of the year due to “limited visibility and market conditions.”

On general market conditions.

“We’re not sure the market, frankly, is any better, other than the fact that it’s the spring and not the winter, and interest rates have somewhat stabilized,” Lord said.

“Today’s higher mortgage interest rates continue to pressure housing prices as monthly payments still remain above 2020 and 2021 levels despite price cuts and rate locks,” Executive Chairman Steve Hilton said.

“We believe that until rates stabilize, home sales activity will remain choppy,” Hilton said.

“We see some potential buyers who could qualify but are waiting for further price declines as they anticipate additional builder incentives are coming,” he said.

“Other current buyers with rate locks in place or below current market mortgage rates were cancelling due to buyer hesitancy as they may have been nervous of the general economy or their own financial positions,” he said.

Reducing construction costs by “aggressively rebidding” and “simplification of the product.”

How can a builder cut their average sales price for orders by 20%, even as their sales orders plunged by 46%, and when their overall margin is just north of 20%?

“We expect that price concessions, elevated discounts, and a continuation of financing incentives for rate locks and [mortgage rate] buydowns will negatively impact gross margins in 2023,” explained CFO Sferruzza. So there’s that.

“Our purchasing team is actively rebidding our vertical costs to capture cost savings as incremental capacity is growing within our supply chain,” Lord explained. “We are pursuing cost savings across all cost categories in all of our markets this year.”

“We’re going through an entire rebidding effort right now,” Lord said. “We’re aggressively rebidding all of our communities for spring starts. We also have been holding off on opening some new communities to really rebid those to get our vertical costs as far as we can.”

In addition, some cost savings are due to “some increased efficiencies and simplification of the product,” he said.

“We’ve seen in some of the hardest hit markets that we’ve recovered over $15,000 per house [in construction costs] which, on a $200,000 construction budget, you can do the math,” Lord said.

“Where we’ve made the most meaningful [price cuts], in Phoenix and Denver, is where we also saw the most meaningful direct cost savings, which have softened what our margins have done,” he said.

“When we quoted earlier in our script that we got $15,000 per house, that’s in Colorado and Phoenix… where the market has adjusted the most, and also where prices ran up the most over the last three years,” Lord said.

“Walking away” from land deals.

“This quarter, we continue to right-size our land portfolio, walking away from underperforming land deals or recently sourced deals where we could not secure closing extensions,” Sferruzza said. In Q4, the builder walked away from about 3,700 lots and booked a write-off of $4.2 million, he said.

But the builder still ended up with 4.5-year supply of lots, within its target of 4 to 5 years. “So we’re comfortable that we have all the land we need right now,” she said.

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