Development giant D. R. Horton’s latest quarterly results, these numbers are a strong indicator that the U.S. homebuilding industry is shifting in ways that will benefit the national economy, even if the trend does irk investors. By market closing on Jan 26th, D. R. Horton posted a 35% increase over a year ago in orders for its first fiscal quarter ending Dec. 31. Each of Horton’s regions gained 26% on a year-over-year basis, demonstrating a widespread improvement over analysts’ expectation of a 25% gain for 2014.
While markedly improved over 2013’s rates, new-home sales for 2014 slumped intermittently throughout the year and average only 57% of the national housing market. But the uptick in new construction bolsters job creation and the U.S.’s GDP. The outlook for 2015 is bullish, with January sales already picking up and an inventory of 1,000 more spec homes ready for sale than last year.
- R. Horton Chief executive David Auld says that “I think we’re better positioned this year coming out of the blocks than we were last year, and we are well positioned to capture what we think is going to be a good spring.” The economic climate for home-buying has improved in all regions, which leaves the developer optimistic about the 2015 market. Lower gas prices and consumer confidence gains due to federal pledges to ease mortgage-lending qualifications standards are also contributors to the rosy outlook.
The part of the story which irks investors is D. R. Horton’s shift from upscale higher-end homes to entry-level starter homes beginning in 2015. The majority of home builders spent 2011-2014 building big, high-priced homes because the more affluent citizens were the only creditworthy homebuyers during that time. The lower inventory of pricier homes has translated to thick profit margins for the company. But entry-level buyers are expected to return to the market in 2105 as federal mortgage criteria relax for first-time buyers. Key to enticing these new buyers is the quality of the incentive package being offered to new homeowners. The incentives also cut into profit margins.
Margins are also being squeezed by the decelerating home prices coupled with increased construction costs. The land currently exiting the development pipeline was purchased in 2012-2013 when lots were becoming pricey. Materials costs and labor shortages also contribute to the shrinking profit margin. D. R. Horton avoided the fate of KB Homes by fully disclosing its predictions of margin decline months ahead of the downturn, and their predictions about rate of shrinkage were accurate. The overall effect, according to Raymond James analyst Buck Horne is that although “the entire home-builder industry has been under pressure as margin expectations have been ‘reset’ due to increased incentives and higher-cost land that will weigh on profitability (this year),” Horton’s margin decline “was well communicated and likely better than many had feared.”
To capitalize on the entry-level boom predicted for 2015, D. R. Horton founded its Express line of new homes. As a high-volume builder, D. R. Horton has the resources and strategic wherewithal to begin the entry-level home building trend. Selling for an average of $169,000, Express homes accounted for 13% of Horton’s bottom line for 2014. Horton’s entry-level home gambit is essential for developing the homebuilding market’s long-term capacity to draw new buyers. Securing customer loyalty early on will translate to brand loyalty in the following decade as buyers upgrade into pricier homes.