Earnings Call Transcript
Green Brick Partners, Inc. (GRBK)
Earnings Call Transcript - GRBK Q3 2022
Operator, Operator
Good afternoon and welcome to Green Brick Partners Earnings Call for the Third Quarter Ended September 30, 2022. Following today's remarks, we will hold a Q&A session. As a reminder, this call is being recorded and will be available for playback. In addition, a presentation will accompany today's Webcast and is also available on the company's website, at investors.greenbrickpartners.com. Joining us on the call today is Jim Brickman, Co-Founder and Chief Executive Officer; Rick Costello, Chief Financial Officer; and Jed Dolson Chief Operating Officer. Some of the information discussed on this call is forward-looking including the company's financial and operational expectations for 2022 and beyond. In yesterday's press release and SEC filings, the company detailed material risks that may cause its future results to differ from its expectations. The company's statements are as of November 3, 2022 and the company has no obligation to update any forward-looking statements it may make. The comments also include non-GAAP financial metrics. The reconciliation of these metrics and the other information required by Regulation G can be found in the earnings release that the company issued yesterday and in the presentation available on the company's website. With that, I will now turn the call over to Jim Brickman.
Jim Brickman, CEO
Thank you. During our call today, we are going to discuss the current housing landscape, Green Brick's overall business strategy, and our land and lot position in much more detail than in past calls. Rick will discuss Q3, 2022 financial results in-depth, and then, Jed will discuss the market dynamics, capital allocation strategy and our supply chain. We are pleased to report another strong quarter despite multiple challenges the homebuilding industry is facing. Residential revenue for the third quarter of 2022 increased 17.1% year-over-year to $397 million, based on an increase in our average sales price of 33%. This contributed to a record high homebuilding gross margin of 32.4%. As a result, the company generated $74 million in net income, or $1.57 per diluted share, representing a year-over-year increase of 65%. Year to date, annualized return on equity was 34.9%, about 1,100 basis points higher than last year. We believe this demonstrates our ability to consistently deliver superior returns to our shareholders. Looking ahead, the U.S. housing market has taken a dramatic shift, as mortgage rates have more than doubled from a year ago and hit a 20-year high in October. Consistent inflationary pressure and high mortgage rates have been keeping potential homebuyers on the sidelines. Despite a strong labor market, consumer confidence has been negatively impacted by geopolitical risks, political uncertainty surrounding the upcoming elections, supply chain disruptions, and particularly how aggressively the Fed is hitting economic brakes to contain inflation. Until the dust settles, we expect the housing inventory and housing market to remain very choppy. While it is difficult to accurately predict what will happen in the short term, our long-term view on the immense imbalance of housing supply and demand remains intact. A decade-long underproduction of housing has resulted in a gap of approximately 4 million housing units that will take many years to adjust if not another decade. Recent and expected future reductions in housing starts are likely to exaggerate the housing shortage. Our markets have one of the best demographics and migration trends. Many builders have already reported the results. As you've heard on these calls, Dallas and Atlanta, which produce over 90% of our revenues, have fared much better than markets such as California, Denver, Phoenix, and Las Vegas. For example, in the DFW and Metroplex, our largest market at 70% of our year-to-date revenues, has attracted over 140 companies for Office relocations and expansions in 2021 and 2022. The resulting migration means more people and more housing. We believe that job growth, economic diversity, a younger population, climate, tax rates, and relative affordability in our core markets, vis-à-vis the rest of the nation will result in our core markets continuing to outperform the nation. Let's take a quick look at slide four of our presentation. Despite the slowdown in sales on a national scale, as shown here, inventory of both existing and new single-family homes remains near historic lows. We take a closer look at Dallas on slide five. In DFW, existing home listings represent a 2.2 months supply on the left graph, and finished new home inventory represents a 1.3 months supply on the right graph. Both measures are below pre-pandemic levels. We expect existing inventory to increase in Q4 and into 2023, but also see that builders are quickly responding to decreased demand by lowering starts. The byproduct of lower starts is that we believe construction costs have peaked. Furthermore, as the third largest builder in DFW, we believe that our scale and this slowdown will provide us leverage to reduce our construction spending. We believe that existing home inventory growth will continue to be limited due to homeowners leasing rather than selling their homes based on this tight market. Inventory will be further limited due to homeowners who have purchased or refinanced over the past 10 years, and particularly during the last three years because they have very low mortgage rates, which disincentivizes selling their residences. We believe that long-term home demand will continue as millennials now need their first home and are financially ready. We continue to see a record level of rents rising in our primary markets, and we highlight the growth of the millennial cohort on page six of our presentation. Please turn to slide seven, where we focus on Green Brick's strategic advantages. First, we have been disciplined and deliberate in maintaining a strong balance sheet. Despite purchasing almost 10% of our stock year to date, our debt to total capital ratio fell to 28%, and our net debt to total capital was 25.5% at the end of the quarter, about 89% of our outstanding debt is long-term fixed rate with an annual cost of about 3.5%. We issued $50 million of perpetual preferred stock in late 2021, at a 5.75% coupon, which would be prohibitively expensive to issue today. Our goal is to always have a superior balance sheet and ample dry powder. Second, as Jed will discuss in more detail later, we have been consistently disciplined with our land investment underwriting, which leads to a superior land pipeline to support our business. Unlike many of our peers who operate under a land-light playbook, we do not use land banking to secure lots. We believe this puts us in a stronger position relative to these peers for multiple reasons. First, cost of financing. The land bankers who provide financing for land-light builders typically charge a high cost of capital, the recent rise in interest rates has made previously expensive land bank capital much more expensive. As noted in peers' earnings calls, because of these increased costs and slowing demand, some builders are walking away from lot option contracts or land bank deals. These are typically in C locations. We expect land banking capital will contract and become more expensive in the future. And third-party lot development will be more challenging. Second, takedown costs. Builders must buy lots from lot developers or land bankers at retail prices instead of wholesale prices. Green Brick, on the other hand, is the developer, a core developer where over 90% of our lots are owned and controlled, giving us a wholesale pricing advantage for the majority of our lots. Third, price escalation. Many lot contracts and most in A location neighborhoods have a 6% price escalator, which means that builders must pay 6% more to purchase a lot the following year, even if the housing market slows further. While there is a lot of renegotiating taking place on option lots, very few renegotiations are taking place on lots in prime A locations. High-quality lots in prime A locations are not easily replaceable, and those neighborhoods are performing better than lots in C locations. Lastly, penalty. Most high-quality option lots demand 15% or more at retail lot price as a first loss earnest money deposit, making it a very expensive proposition for builders to walk away from their lots. At the end of the quarter, we own and control approximately 26,000 lots. We have no need to buy land to grow our business and don't plan to buy much or any land in Q4 2022 or well into 2023. Our third strategic advantage is location, location, and location. Not only do we operate in some of the best markets in the country, but we also primarily build in infill sub-markets. Over 80% of our year-to-date revenues were generated from those indoor markets where supply is constrained, accompanying significant demographic tailwinds. We believe our markets will outperform the rest of the country. Jed will expand this discussion on our land and lot position, as well as our preferred locations later on. Fourth, operational efficiency. We have invested significant capital and resources to improve our technology and processes across Green Brick's brands. These investments have provided us more transparency into our workflow and cost structure. As a result, as the market slows, we believe that we will have the ability to react quickly to improve overhead efficiency and negotiate what we think will be better pricing with vendors and subcontractors. Finally, and most significantly, as shown on slide eight, our industry-leading gross margins at 32.4% give us a tremendous amount of power to manage pace versus price. With that, I'll now turn it over to Rick.
Rick Costello, CFO
Thank you, Jim. Please turn to slide nine of the presentation. Our total revenues in Q3, 2022 increased 19% year-over-year to $408 million, primarily driven by a 33% increase in the average sales price of closed homes to $607,000. This was partially offset by a 12% decline in the number of closings to 650 homes. The decline in the number of closings was due to the lower start pace in prior quarters and a smaller backlog entering the quarter because of weakened demand. Higher residential unit revenues led to a 550 basis point year-over-year improvement in homebuilding gross margin, which was 32.4% in Q3 of 2022, breaking the previous record of 32.3% set in Q2 of 2022. Although we are not likely to maintain this level of margin in this housing market, our ability to outperform our peers has been consistently demonstrated quarter-over-quarter, and we believe we will continue to generate superior margins in more trying times. SG&A leverage ratio increased slightly year-over-year to 10.9% during the third quarter of 2022. As a result of higher revenues and gross margins, net income attributable to Green Brick grew 52% year-over-year for the quarter. Additionally, our reduced tax rate resulting from energy tax credits further improved diluted EPS for Q3, 2022 to $1.57 for the quarter, a year-over-year growth of 65%. As mortgage rates rose to their highest level in 20 years, housing demand cooled quickly. Net new home orders during the third quarter of 2022 decreased 41% year-over-year to 404, while our quarterly absorption rate per average active selling community decreased to 5.3 homes. Despite the lower sales pace, our decline in new order revenues during the third quarter was just 34%, smaller than the decline in order count as our average sales price in new orders rose by 12.5% from $553,000 to $622,000. Our cancellation rate increased to 17.6% for the third quarter of 2022 compared to 6.9% for the same period last year and was up from 11.4% last quarter. As you would expect, our cancellation rate is the highest with Trophy's entry-level buyer. We do not see this improving soon. Jed will provide more commentary on sales and market dynamics. On slide 10, we highlight our year-to-date results. Our total revenues were up 40% year-over-year on an ASP increase of 31%. Our year-to-date gross margin was up 460 basis points to 31.1%, and our SG&A leverage improved 150 basis points to 9.4%. Our net income attributable to Green Brick was up 86% with our diluted EPS up 94% year-over-year. Our annualized year-to-date return on equity was up 1,090 basis points to 34.9%, the highest among our peer group. Backlog at the end of the third quarter of 2022 declined 45% year-over-year to $564 million. This was due to a 54% drop in backlog units, partially offset by a 20% increase in the average sales price of backlog units. The drop in backlog units is a function of the lower levels of new home orders and the higher cancellation rate described above. As a result of fewer sales, an increase in units closed, and a decrease in backlog units, spec units under construction as a percentage of total units under construction rose to 65% at the end of September 2022 from 31% a year ago. We are assessing our inventory level on a daily basis to make sure we are aligning our sales pace, starts, and construction. Consequently, we expect to start fewer homes in Q4, and this trend will likely continue into the first part of 2023. As Jim mentioned earlier, we continue to deleverage our balance sheet with strong operating cash flow and one of the lowest debt to total capital ratios of 28%. As of September 30, 2022, our weighted average cost of debt was 3.5% and 89% of the outstanding debt was fixed. Maintaining the strength of our balance sheet will remain a top priority. I will now turn it over to Jed for market commentary.
Jed Dolson, COO
Thank you, Rick. Please turn to slide 11. The impact of rising interest rates was felt in our markets. As Rick mentioned earlier, our net sales orders during the quarter were down 41% year-over-year, with revenues on sales orders down 34% because of our continued increase in average sales price. And as seen on this slide, even though our cancellation rate has continued to go up since May of this year, it is still outperforming most of our peers. Cancellations were heavily weighted to buyers who signed contracts when interest rates were lower. We also experienced higher cancellations among products with lower price points and lower deposits compared with the rest of our portfolio. People are still buying houses as there is still unmet demand. We have non-discretionary buyers who need to move out of rentals due to milestone changes in life, such as marriage, new child, or new job. During this price discovery phase, we continue to be laser-focused on several key priorities that we laid out last quarter, which are: one, preserving backlog and acting quickly to restore sales momentum; two, being stringent and nimble with capital allocation; and lastly, managing bottlenecks in the supply chain to bring down production costs and cycle times. We are carefully managing our sales pace and starts on a community by community basis. The market as a whole experienced an abrupt slowdown in June. Since then we've adopted more aggressive incentives in underperforming communities. Sales activity picked up in the second half of July, while mortgage rates temporarily dropped before rising again in the second half of August. With an increased level of incentives, we were able to entice a reticent market and maintain a constant sales pace from June through September. Overall, discounts and incentives for new orders were up from 2% the previous quarter to 4.2% in Q3 2022. During October, traffic and sales pace have been slower, with monthly sales down approximately 19% versus the prior four-month average, and incentives increasing from 4.2% to 6.3%. Discounts and incentives include base price reductions, rate buydowns, and other closing credits. We expect elevated incentives, higher cancellations, and lower sales volume to remain the biggest headwinds to our margin performance in the near term. We will continue to monitor the market carefully to adjust our pricing and to balance starts in inventory with sales. As Jim noted, our industry-leading gross margins allow us to be very aggressive in pricing our houses. Next, we continue to focus on managing capital allocation prudently. Considering current market developments, we have significantly slowed down on land acquisitions and expect the trend to continue until the market adjusts. Additionally, we conducted a thorough review of our lots owned and controlled. As a reminder, a vast majority of our lots were purchased before the upsurge in land prices on top of conservative underwriting. Therefore, our underwriting for these lots still generates adequate returns in today's environment, and we do not see immediate impairment risk and have no communities on a watch list. Given recent volatility in the market and slower sales, we are planning to postpone land development in certain communities that are entering the next phases of land development. As shown on slide 12, and in 13 communities that have been delayed in the DFW area are more periphery locations, while the majority of our land book in DFW and Atlanta are in infill locations. We've projected our land and lot development spending will decline approximately 45% next year from full year 2022. We are surveilling the market conditions to determine the best cadence and timing for the resumption of these development projects. Please turn to slide 14. The self-developing nature of our land business gives us tremendous flexibility to control delivery schedules and costs and an upper hand on achieving higher margins. Despite a slowdown in development, we expect to complete all of our 880 finished lots between 2022 and 2023 in 73 communities. As shown on slide 15 and 16, our 2023 deliveries in DFW and Atlanta will be concentrated in infill and adjacent desirable areas. Depending on market conditions, as many peers pull back, we expect to have the opportunity to increase our count on ending active selling communities by 20% to 30% from the end of September over the next four to five quarters. We believe these new communities with a favorable land and lot basis provide the optionality of aggressively pricing without the overhang of protecting backlog. We also believe this will generate favorable sales per community at more traditional gross margins. We expect this capability will be an opportunity to build market share and effectively manage price versus pace decisions. In addition to the flexibility regarding timing of community obedience, our self-development of lots is expected to generate higher margins, and therefore more pricing flexibility compared to builders who have accumulated higher price lots from third-party developers. This also provides us with the capability to start more homes under construction without an outlay of cash to purchase these finished lots when demand returns. Next, I would also like to provide some updates on our expansion into Austin. In August, we fulfilled several key roles including our new division president Ryan Jerke to operate the Trophy brand in Austin. Ryan brings tremendous experience and knowledge in homebuilding, and we are excited to have him join the team. Austin is a tough market today, but we think we will be able to deliver homes from $275,000 where there's pent-up demand. We will keep everyone posted when we break ground on homes in early 2023. The last focal point for us is to value engineer to bring down cycle times and costs. Our cycle time for homes closed during Q3 of 2022 varied significantly by brand and price point, but in aggregate shortened modestly by 21 days sequentially. Although we are not back to pre-COVID levels, we are pleased to see improvements in the supply chain across multiple categories, especially with front-end construction. The fluctuating nature of construction across the industry gives us more leverage and negotiations on new communities as we become more selective with vendors regarding both pricing and quality. To be clear, we're still experiencing struggles in certain aspects of the supply chain. However, we will continue to work with our trade partners to resolve bottlenecks in the supply chain and unlock additional savings. With that, I'll turn it over to Jim for closing remarks.
Jim Brickman, CEO
Thank you, Jed. I would like to thank our entire Green Brick team for their continued hard work in this more challenging environment. We believe that Green Brick is entering this cycle in a strong position; we have a significant footprint in some of the best markets in the country, a broad spectrum of product types and customer bases, a strong balance sheet, ample dry powder to deploy, a disciplined land pipeline to support growth, and most importantly, an experienced team in place to navigate our business in this environment and achieve our long-term goals. As far as stock buybacks and capital allocation are concerned, for the first time in many years, we think unique investment opportunities may arise in 2023. Consequently, we expect to evaluate buying back stock versus these direct investment opportunities as the opportunities arise. This concludes our prepared remarks. We will now open the line for questions.
Operator, Operator
Thanks. We'll take our first question from Carl Reichardt with BTIG.
Carl Reichardt, Analyst
Thanks. Good morning, guys, or afternoon, or I'm not sure what time it is actually. I wanted to ask about the SG&A, which was ahead of what we were expecting. And there was some negative leverage despite the relatively good-sized increase in revenue. I know there was some unabsorbed overhead I think you said in the queue. Can you just expand on why that number increased year-over-year on a percentage basis? And then, what kind of run rate should we be thinking for core G&A on a go forward basis?
Rick Costello, CFO
Those are great questions, Carl. This is Rick. For the first, particularly if you look Q-to-Q, we went from $512 million of homebuilding revenues in Q2 down to $397 million in Q3. So most of SG&A, I shouldn't say that. Commissions generally are going to be your most significant singular variable cost. In the short run, a lot of your overhead are going to be fixed costs; in the long run everything is variable, right? So about 60% of the quarter-to-quarter increase from 8.2% to 10.9% was that function of math, just having a bigger denominator versus your costs, because cost excluding commissions were in about the same other than the other 40% about a 1% Delta related to a cumulative year-to-date incentive comp adjustment, an increase for the kind of year that we're having. But if you normalize that, that would have only been 0.3% sort of 1% in the quarter. So, it would have been about 10.2%. It's a lot more interesting to talk about the long-term run rate because we're going to be cutting costs, just in this view of having fewer starts until demand comes back more robustly. We're going to be looking to chop that number down. So lower is the answer.
Carl Reichardt, Analyst
But that will lag?
Rick Costello, CFO
It will have more lag. It'll always lag. As you know, we still have a bunch of homes to complete at this point.
Carl Reichardt, Analyst
Okay. All right. I think I got that. And then, Jim, I have a question here. And you got to hit at the very end of your remarks, which is obviously Green Brick was started at effectively the bottom of an awful housing market. We're looking at least some struggles in the near to intermediate term. So when you're thinking about opportunities, are those opportunities that you think you'd see in your existing markets and an opportunity to grow your share? Or is this the opportunity for Green Brick now to begin to spread its wings into new markets? I'd just like your perspective on that. Thanks.
Jim Brickman, CEO
Okay, Carl. Well, first of all, we quit seeing much deal flow from brokers to sell builders because they knew we wouldn't buy based on rosy going forward assumptions. So, I'd like to say that we see a lot of deals, but frankly, we didn't, because they knew that we weren't going to be buyers. Right now, we are in a cyclical business. I think this is my fourth real estate cycle. I've never seen a real estate cycle where optimism did revert to realism. So that's why I think that maybe, may be the operative word, be opportunities in 2023 purchasing a private builder for the first time because I think you're going to see optimism revert to realism and pricing adjust accordingly. The perfect scenario would be to find a private builder that fits our culture and more importantly, fits our economic hurdle rates in a southern or southeastern market.
Carl Reichardt, Analyst
Great. I appreciate that color. Thanks very much. I'll get back in queue.
Operator, Operator
We'll take the next question from Michael Rehaut with JPMorgan.
Unidentified Analyst, Analyst
Hi, everyone. It's Andrew on for Mike. I appreciate you taking my question. Congrats on the results this quarter. I wanted to ask if you can give us some of your thoughts around directionally how gross margins might be shaping up over the next one or two quarters?
Rick Costello, CFO
I think I'll start and then Jed can add in later. He practices almost daily, focusing on different neighborhoods. In the A-Class infill neighborhoods, we're seeing stable margins because of the limited supply and competitive lot positions. I don't want to sound overly optimistic, but we did raise prices in a million-dollar neighborhood this week and we're seeing strong demand even though the sales pace is slower in a prime location. The neighborhoods that are hard to predict right now are the C location ones. Jed will mention that most of our neighborhoods are not classified as C locations, but Trophy has a few. We anticipate it will be more challenging there because of the increased number of builders nearby and the commoditized nature of housing. Ultimately, our gross margins will largely depend on the actions of our competitors in those areas. So your estimate is as good as mine.
Jed Dolson, COO
Yes. I would like to add that our gross margin will be impacted by financing and increased commissions, which are likely necessary to incentivize sales in these challenging peripheral markets.
Unidentified Analyst, Analyst
Okay, great. Thank you for that color. And then, you mentioned raising prices in your Triple A market. So, how should we be thinking about closing ASPs in the next two, three quarters ahead of you opening these new communities?
Jim Brickman, CEO
Jed, why don't you address the product mix question, since we're not increasing prices in many areas, as they are either stable or declining.
Jed Dolson, COO
Yes, I believe our average selling price will continue to rise slightly. We've noticed that in our peripheral locations, where we were previously selling 10 to 12 units a month, sales have now dropped to around four. This represents a significant decline. In contrast, most of our communities are situated in prime locations, where we've experienced a smaller decrease in sales, going from four to three units a month. Thus, the percentage drop in these advantageous areas, which make up the majority of our communities, is noticeably less, and the average selling price in these communities tends to be quite high.
Rick Costello, CFO
Andrew, I think that probably some of the best color we gave was on just the increase in October of the average discount going from up to 6.3%. So that's going to have an impact certainly on the ASP in part if it's a price discount and/or on incentives, so it becomes a little bit of a combination between gross margin hit and just write off the top for a discount.
Unidentified Analyst, Analyst
Okay, great. Yes. Super helpful to get your thoughts on that. I'll get back in the queue. Thank you.
Operator, Operator
We'll take our next question from Jay McCanless with Wedbush.
Jay McCanless, Analyst
Hey, good afternoon, guys. So Rick, I did not follow your answer to Carl on the SG&A questions. Can you talk about why that was up year-over-year and what we should be forecasting going forward?
Rick Costello, CFO
Well, the bottom line is, it's a function of lower revenues, and the cost structure is going to have to come down. So, it was probably 0.7 too high this quarter for the incentive comp adjustment. And otherwise, it's going to be a function of us making adjustments to the core cost probably the beginning of 2023.
Jay McCanless, Analyst
Okay. And then, Jed, in your prepared comments.
Jim Brickman, CEO
Yes. And I wouldn't expect a big decrease in SG&A in 2023. We're going to start addressing the cost structure more into 2023. We don't want to have a knee-jerk reaction to that, based upon three or four months of sales, but we're watching very closely.
Jay McCanless, Analyst
Okay. Thank you, Jim. And then Jed, in your comments, I caught about half of it. I think you said something about 20% to 25% community growth? Is that what you said for next year?
Jed Dolson, COO
Yes.
Jay McCanless, Analyst
Okay. And does that community growth include the potential purchase of the southern builder you were talking about, Jim? Or is that you've already have under contract?
Jim Brickman, CEO
We have no plans for a builder. And we have some maps in our slide deck showing new community opening locations that I think investors really need to stay in tune with that map and your presentation with slides that is there.
Rick Costello, CFO
There are a couple of slides, specifically slides 15 and 16. However, slide 14 is particularly relevant as it highlights that we have a total of 73 communities where we will be delivering lots between this year and next year. This will be a key factor in the opening of those communities and will drive growth in 2023.
Jim Brickman, CEO
And what's really interesting, we don't get this granular in our presentations. But if you take a look at the slide deck on 15, and you take a look at where those communities are opened, you can see that they're in areas that are most desirable. I don't think any CEO is jumping up and down excited about what's happening in the market. But we're relatively optimistic because the communities that are opening in these new highly desirable neighborhoods have a very favorable lot cost. We purchased them when the land was low; some of them have low-cost mud debt on them. We already have other neighborhoods not far from that. Our lot cost in these new neighborhoods is very favorable compared to our older neighborhoods that are already producing very nice margins. So we feel good about that. You'll see two dots; there are a few dots that are not in the highly desirable locations. And as we said in the call, those are in more Horton higher competitive neighborhoods where there's more competition, and we're going to see margin compression in those neighborhoods. We just don't know what it's going to be because we know we can price a house more than Horton because frankly, it's fresher architecture, more windows, better indoor-out-door living space, but we can let go some of the spread over a Horton product can only be so much.
Jay McCanless, Analyst
So, to that end, Jim, if this is a longer-term downturn than a shorter one, what's the future for Trophy Signature? You just put a lot of that land in mothballs and wait till Jay Powell's jacking up rates, or what's the near to medium term outlook for Trophy Signature?
Jim Brickman, CEO
Well, obviously, it's going to be harder to grow Trophy Signature unless you want to take lower margins. So we're going to evaluate that. We've already made the investment in land. So, in terms of return on capital stuff that we think is going to be accretive, but how accretive we don't know. In terms of Austin, for example, we're looking at what we're doing in Austin; we think we can still be very successful in Austin because we can price a home under $300,000. We think there's a huge amount of demand. And in this market, it's kind of a winner-take-all because the consumer is so smart. And if you open it at $300,000 and you can make decent margins, and some other builders not far from me at $350, you don't get one incremental sale, you get 10 a month.
Jed Dolson, COO
Yes. I would just find that, Jay, I would just add that our lot cost basis in a lot of these periphery locations is around $50,000. We saw our vertical construction costs really kind of run out of control, not just us but the whole industry to say, where it was costing close to $200,000 a house to build. We think we can beat those down in the $150,000 to $175,000 range and really deliver, as Jim pointed out, a much cheaper product at a very industry-standard, historically nice gross margin of 25%, 26%.
Jay McCanless, Analyst
And thank you for that, Jim. But the last one I had. If infill is still selling that well, and on the company average, you had a 41% order decline. I guess what was the level of declines in the softer areas versus the level of declines in the better areas for the quarter?
Jed Dolson, COO
Yes, this is Jed, I'll take that. I don't have the exact numbers, but the decline in cancellations in the A locations was at least half of what it was in the periphery locations. And right now.
Jim Brickman, CEO
And the real problem in the periphery locations is not demand; it was the cancellation factor that was so much higher than the A locations. Now, we're taking $60,000, $70,000 in some of the higher-end price points, a lot of deposits. And obviously, those people are more qualified, and they're less likely to walk away from $65,000 at an entry-level buyer. That puts $5,000 in a house or cancels late; it was really affecting the sales pace. The demand was there. Our cancellations were too high. I think they were running 29%, 30% at Trophy. And sometimes, and in some week, they can even be higher than that. And they're much lower than that for the aggregate of the rest of our builders.
Jay McCanless, Analyst
Okay, great. Thanks for taking my question.
Operator, Operator
We'll take our next question from Alex Rygiel with B. Riley Securities.
Alex Rygiel, Analyst
Yes, good afternoon. First, quick clarification. Did you see that incentives and cancellations increased in the month of October?
Rick Costello, CFO
Yes. Incentives went from 4.2% in Q3 to 6.3% in October, for instance.
Alex Rygiel, Analyst
Helpful. And then, how many finished spec homes did you have at the end of the quarter?
Rick Costello, CFO
63.
Alex Rygiel, Analyst
And then lastly, what's your land spend likely to be for 2022?
Jim Brickman, CEO
I don't think we provide that detail. I think we were internally taking a look at land spend in 2022 and 2023, and I think it was going to be anyway within about $140 million Delta.
Rick Costello, CFO
Yes. We're going to be down 45% between land and development spend from 2022 to 2023. And the Delta on that is about $150 million.
Alex Rygiel, Analyst
Thank you very much.
Jim Brickman, CEO
But that's somewhat fluid, depending on costs and other phasing issues that we're looking at right now. Obviously, with lower demand, any time that we can reduce development spend, that's a good idea. And we really evaluate that on a neighborhood-by-neighborhood basis. All of our builders are coming to Dallas on November 8th and 9th to discuss that issue with us.
Alex Barron, Analyst
Yes. Thank you very much. I wanted to see if you guys could provide the number of starts this quarter and how that compared to last quarter and last year?
Rick Costello, CFO
Yes. It's actually that you can do the math pretty easily. Every quarter, we tell you what the closings are, obviously, and we tell you what the ending units under construction. But in Q3, we started 490 homes.
Alex Barron, Analyst
Okay. And a year ago?
Rick Costello, CFO
A year ago was 801.
Jim Brickman, CEO
It's very difficult to compare COVID sales results and required starts with other periods because it can skew your results. In hindsight, I wish we had delayed selling some of the homes we started at 801 due to the cycle times.
Alex Barron, Analyst
Right. My next question was, with these new communities that you guys plan on opening and where you said you have a cost advantage. Does that imply that you will open them at lower prices than you would have otherwise to gain an advantage over other builders?
Rick Costello, CFO
Well, first of all, we don't set the price. But we do know that you can hit a jet stream of buyers offering a real value when you're in a peripheral neighborhood compared to peers. So our pricing strategy really is very dependent upon neighborhood location. In terms of opening some of these new neighborhoods, one of the things we're going to be very cautious of is that we want to get sales kicked off better, and we want to be able to raise prices and not have to worry about the impact of pricing on backlog. So I think we can be more competitively priced, whereas in some existing neighborhoods, we had a large backlog. We frankly didn't want to jeopardize that backlog and get too aggressive on pricing when we only had, say, 20 home sites left in the neighborhood.
Alex Barron, Analyst
But does that imply that most of these homes are going to be specs that you sell very close to completion?
Jim Brickman, CEO
Yes, I believe we are seeing more spec homes, and we finished the third quarter with 65% of our homes being specs. I anticipate this trend will continue for two main reasons. First, buyers currently are hesitant to take risks with interest rates. They prefer to move in quickly, usually within two months after contracting for a home, due to concerns about rising interest rates. Additionally, they are worried about job stability, costs, and various uncertainties that were not present a year ago.
Alex Barron, Analyst
Right. Okay. Well, that makes sense. Now, if I could ask one more, some builders have said that they plan on maintaining a certain sales pace, let's say three or four months, and that they're just going to keep finding the market clearing price. I'm curious if you guys share that philosophy, or if you look at the world from a different perspective?
Jim Brickman, CEO
Well, it's going to be interesting in the A locations, we don't look at the world that way because we don't have to. And in the periphery locations, as I said, they said, what's going to happen to our gross margins? And when you say things, like, some peers are going to maintain sales pace, obviously, if we want to maintain sales pace, we're going to be impacted by those guys because we're down the street. So, we're going to have to see what they do.
Alex Barron, Analyst
Got it. Okay. Well, best of luck. Thank you.
Rick Costello, CFO
Thanks, Alex.
Operator, Operator
We'll take a follow-up question from Jay McCanless with Wedbush.
Jay McCanless, Analyst
Thank you for taking my call. I have two questions. First, regarding the cost actions you mentioned possibly starting in 2023, how do you plan to implement those cost actions while achieving community growth of 25% to 30% or 20% to 25%? Can you explain what staffing levels will be necessary to support that level of community growth?
Jim Brickman, CEO
Well, the community level growth is more of an indirect cost. A lot of those costs. Rich, you want to chime in on that?
Rick Costello, CFO
Yes. We have capacity with many of our builders and demand for a few projects. When starting a community, you typically begin with a limited number of models to build, aiming to open them quickly and start production. This creates a gradual build-up over time. Transitioning between old and new communities or adjusting the number of superintendents introduces variable costs related to our field overhead over the next six to twelve months, depending on sales. We measure our starts by our sales pace, so much of the answer regarding the right number of personnel in the field hasn't yet been determined. It involves strategically rearranging our resources while ensuring we retain our strongest team members. I can't provide specific figures because we will need to figure this out as we progress.
Jay McCanless, Analyst
And then that 6.3% in incentives for October, and I apologize, I don't remember how you guys lined those out. But is all that going to hit the gross margin or some of that going to show up in SG&A?
Rick Costello, CFO
No, it's all in gross margin. It's in between price drops or closing cost incentives for buydowns, et cetera. The only thing that's going to be below the line would be anything that we do with the brokerage community on promotions to them.
Jay McCanless, Analyst
Okay, great. Thanks again. Appreciate it.
Rick Costello, CFO
Sure.
Operator, Operator
And that concludes the question and answer session. I would like to turn the call back over to Jim Brickman for any additional or closing remarks.
Jim Brickman, CEO
Now, we would just invite anybody to give us a call in person if you have any questions. The market is challenging. It's not impossible. We've been through this before and we appreciate everybody's support.
Operator, Operator
And that concludes today's presentation. Thank you for your participation and you may now disconnect.