Taylor Morrison Home Corp Q4 FY2021 Earnings Call

Good morning, and welcome to the Taylor Morrison's Fourth Quarter 2021 Earnings Conference Call. My name is Jemma and I'll be the operator today. Currently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce Mackenzie Aron, Vice President of Investor Relations. Please go ahead.

Thank you and good morning. Before we get started let me remind you that today's call, including the question-and-answer session includes forward-looking statements that are subject to the Safe Harbor Statement for forward-looking information that you will find in today's earnings release, which is available on the Investor Relations portion of our website at www.taylormorrison.com. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the SEC, and we do not undertake any obligation to update our forward-looking statements. In addition, we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in the release. Now let me turn the call over to Sheryl.

Thank you, Mackenzie and good morning, everyone. I am pleased to also be joined today by Lou Steffens, our new Chief Financial Officer; and Erik Heuser, our Chief Corporate Operations Officer. Lou officially stepped into the CFO role January 1 after several years spearheading our transformational M&A strategy and integration execution. And he is nearly 15 years with the company, Lou also held a number of Regional and Area President roles and I am thrilled to be kicking off 2022 with him in this new capacity. Erik leads our strategic direction and oversees our land investments, as well as our sales, marketing and research teams. He joined us this morning to provide an update on our strategic partnerships with a focus on our Build-to-Rent business. Before we dive in, I want to begin by acknowledging the extraordinary efforts of our Homebuilding and Financial Services team members throughout 2021 and especially in the fourth quarter. Their dedication and resiliency allowed us to end the year on a high note to deliver record-breaking results for our organization, while serving our homebuyers with an uncompromising commitment to construction quality and customer service, despite the severe supply chain disruptions felt across the industry. Our customer-centric approach is key to our long-term success and I believe has become even more differentiated in this challenging operating environment, as we recently earned the coveted distinction of America's Most Trusted Builder for the seventh consecutive year. With our highest trust index score yet, this special recognition is a testament to our tremendous team members across the organization. Let me review just some of the other highlights of the past year. In 2021, we increased our home closings by 9% to 13,699 homes. Expanded our home closings revenue by 22% to nearly $7.2 billion and improved our home closings gross margin by 370 basis points to 20.3%. We also realized meaningful cost leverage and benefited from the strong performance in our Financial Services business. As a result, our pre-tax margin improved by over 600 basis points and we grew diluted earnings per share by 176% each to new company highs. These strong results were achieved even with the unpredictable labor and material constraints that added significant complexity, extended construction timelines, and pressured costs throughout the year. While I'm anticipated fourth quarter closings and community openings were delayed because of these challenges, we are well-positioned heading into 2022 to realize another year of significant growth in revenue and profitability as we continue to navigate the supply headwinds and benefit from our strategic focus on operational and capital efficiency. This year, we expect to deliver between 14,000 to 15,000 homes at a home closings’ gross margin of at least 23.5%. The strength and margin outlook implies more than 300 basis points of year-over-year improvement and nearly 700 basis points over the last two years. Combined with our focus on optimizing our balance sheet and cash flows through land lighter investment and disciplined capital allocation, we also now expect to generate a new company high return on equity in the mid-20% range. As I have shared before since reaching the critical inflection point in our integration of William Lyon Homes last year, the largest and most transformative of our six acquisitions since 2013. This phase of our strategic journey is focused entirely on capturing the many advantages of our enhanced scale and portfolio diversification that has transformed our ability to generate long-term value. From an operational perspective, while we have made significant progress in rolling out enhanced processes, we still have meaningful opportunity ahead to further enhance gross margins and improve asset efficiency. For example, we rationalized our floor plans in 2021 and are targeting additional reductions this year, even as we open more communities. We are also eliminating option variation within the plan rebuild, which is even more beneficial to our construction efficiencies. In 2021, our option library was reduced by more than 30% and will benefit further with the introduction of new National Design Specifications in the coming quarters. This strategic simplification allows us to streamline production and leverage our supplier relationships while ensuring we are offering only the most profitable and consumer desired plans. These efforts are supported by the growing share of our starts under our new curated option program known as Canvas, which represented approximately 15% of our second half net sales and we will steadily ramp higher throughout 2022. In fact, approximately 70% of our existing communities now offer Canvas, and all new community openings going forward will. With a simplified design process and faster cycle times, this program is driving greater production efficiency, improved profitability and a better customer experience. This focus on operational performance is matched by our focus on capital efficiency to drive greater cash flows. This includes strengthening our balance sheet and executing on new capital efficient land financing tools. After increasing the controlled percentage of our land portfolio by approximately 700 basis points to 38% last year, we now expect to grow our controlled share to approximately 45% by the end of 2022, as the new land financing vehicles that we established last year with Varde partners have accelerated our land lighter balance sheet strategy. These cost-effective arrangements improve our ability to finance new land investments, reduce the amount of inventory held on our balance sheet, minimize long-term risk and meaningfully improve expected return. As Erik will discuss, I am pleased to share that we expect to add additional financing capacity specific to Build-to-Rent projects that will enable us to cost-effectively scale this growing segment of our business. From a demand perspective, during the fourth quarter, we continued to benefit from favorable trends across each of our consumer groups and geographies. Strength was most notable within our move-up segment, which experienced year-over-year growth in both net orders and absorption pace and represented slightly more than half of our total sales versus 44% a year earlier. Our 55 plus Active Lifestyle segment also continues to enjoy strong momentum. Thus far into the new year, consumer engagement across our portfolio has remained healthy and our monthly sales pace has been consistent with the 3.2 pace experienced in the fourth quarter. While this is down from the record-breaking activity experienced in the first quarter of 2020 to more sustainable levels, we believe underlying demand is strong and supported by demographic trends at both ends of the buyer spectrum, evolving consumer needs and preferences, migration trends and limited availability of new and resale supply. However, given the significant tightness in the supply chain, we have remained disciplined in our sales strategy to align net orders with construction capacity. As a result, approximately 75% of our communities needed sales activity during the fourth quarter and a similar share raised base pricing, which helped drive a 23% increase in our average net order price. By prioritizing production ahead of sales and carefully balancing price and pace at the community level, we successfully increased new starts per community by 7% year-over-year to 3.4 during the quarter and more than doubled our inventory of spec homes to six spec homes per community at quarter-end from just 2.8 homes at the end of 2020, of which only a handful of those homes were completed. In today's supply constrained market, this disciplined approach is providing greater visibility into our costs, improved efficiencies and a better customer experience by releasing the homes for sale as they progress through the building cycle. Before I turn the call over, I want to spend a moment discussing our buyers' financial position and affordability considerations. As I share every quarter, one way we gauge affordability is by tracking the interest rate qualification buffer of our homebuyers financed by Taylor Morrison Home Funding, which had a capture rate of 82% in the fourth quarter. We test the strength of these buyers by determining the maximum allowable interest rate they could have qualified for after considering compensating factors versus our actual interest rate. For our conventional borrowers, which accounted for 84% of fourth quarter mortgage closings, this spread was stable at roughly 700 basis points. For our government, FHA and VA borrowers, the spread compressed slightly on a sequential basis but remained healthy at 400 basis points. More conventionally, because our buyers generally have strong credit profiles with an average credit score of 752 and a debt-to-income ratio of 36% in the fourth quarter, they have many levers to pull to offset higher rates or prices if necessary. Even more meaningfully, we estimated our customers in backlog could absorb a similar increase in interest rates before adjusting their loan terms. However, as you would expect, first-time homebuyers have experienced slightly more affordability compression than our overall portfolio. In addition, our backlog is secured by substantial deposits of nearly 8.5% and more than $53,000 per unit on average. Collectively, these favorable trends supported below-average cancellation rates of 8.2% in the fourth quarter and a company low 6.6% in 2021. Nevertheless, we are mindful of the significant movement in home prices and interest rates recently and have taken proactive steps in our product design and spec inventory choices to ensure continued affordability, particularly in our entry-level communities. Lastly, before turning the call over to Erik, I want to highlight that we were recently recognized as the only homebuilder on Bloomberg's Gender-Equality Index for the fourth consecutive year for our long-held dedication to supporting diversity at all levels of our organization. This commitment to quality and transparency was recently strengthened further when we welcomed Christopher Yip to our Board of Directors, making the majority of our Board diverse. We expect a significant experience in real estate technology to complement our focus on digital innovation. Now, Erik will update us on our expanding Build-to-Rent operations, which is well on its way to becoming a meaningful and accretive portion of our overall business.

Thanks, Sheryl and good morning, everyone. Since first announcing our entry into the Build-to-Rent arena in 2019 by way of a strategic relationship with our brand partner Christopher Todd Communities, the long-term opportunity to serve both the renter-by-choice demographic and those impacted by rising home prices has only strengthened further. This business enables us to leverage our core production homebuilder strengths of land acquisition, development, and construction to deliver innovative rental communities that we believe fill a void in the market. Unlike many other single-family rental offerings, our gated, villa-style communities offer residents well-appointed amenities, social programming and generally one or two-bedroom single-story homes that are equipped with smart technology, pet-friendly features and private backyards. The average size of these communities is approximately 175 homes, with an average rental rate of $1,700 per month for a typical 1,000 square foot average unit, making them a compelling affordable option for many prospective customers. In addition to the demand opportunity, these communities which generally offer two floor plans provide new ways to capitalize on streamlined construction processes. This supports accelerated cycle times with roughly 20 starts targeted per community per month. We also expect to garner benefits associated with organically growing cost-effective customer leads that will eventually benefit our for-sale business. As we continue to scale this segment, our priority has been to develop an efficient operating playbook and capital infrastructure to support return-accretive growth. Over the last two years, we have strategically expanded our market penetration and established a robust land pipeline that will fuel accelerating community growth in the coming years. We now have an active Build-to-Rent presence in nine of our 19 markets of operation, with a handful of additional markets being evaluated for entry opportunities in 2022. While each of these markets is at a different stage of scaling, we have approximately 20 land deals that represent a portfolio of over 4,000 controlled lots, with an additional 20 to 25 deals planned for 2022. We expect to roughly double our controlled lot count by the end of the year. Once land is controlled and entitled, the horizontal and vertical construction process requires roughly two years before a community is ready to begin leasing, and an additional year for stabilization and prospective disposition. With our first community in Phoenix having recently begun leasing, we expect to evaluate exit strategies once it has reached our stabilization expectations later this year and are targeting an asset sale by year-end. Based on the timing of other projects under development, we expect to have several additional communities fully leased and ready for disposition in 2023, followed by strong growth in 2024 and beyond. With an extremely favorable investment environment for such yield-based horizontal apartment communities, we expect exit optionality to be high, with buyers ranging from financial partners to private equity, family offices and others. Given the production efficiencies, no need for commission expenses and overall market strength, expected margins are modestly accretive to our traditional business, while levered returns are targeted to exceed 30% given the ability to finance the projects in a capital-efficient manner. As Sheryl noted, we continue to progress the expansion of our land financing arrangements and expect to complete a vehicle targeted specifically to Build-to-Rent projects in the near future. Before the benefits of contemplated leverage, we expect to dedicate 40% of the capital to such a venture and look forward to sharing more details in subsequent quarters. Lastly, it is also worth sharing that we intend to further leverage our Build-to-Rent strength in the traditional single-family rental sector by developing and building rental homes and full communities targeted for disposition to SFR investors. In fact, we have recently approved our first bulk SFR project. This is yet another channel to maximize our operational scale, capitalize on market demand for rental assets, and enhance our long-term returns. With that, I will turn the call to Lou to discuss the company's financial review and outlook.

Thanks, Erik and good morning, everyone. I'm excited for the opportunity to speak to you all today and look forward to getting to know you in this new role. I will provide an overview of our strong fourth quarter earnings results and our detailed financial guidance for the first quarter and full year. To begin, we generated fourth quarter net income of $273 million or $2.19 per diluted share, which was up 204% year-over-year. On a pre-tax basis, our income margin equals 13.7%, up 610 basis points from the prior year. Turning to our operations. We delivered 4,283 homes during the quarter at an average selling price of $558,000, which drove a 61% year-over-year increase in our home closing revenue to $2.4 billion. Homes closed were slightly below our prior guidance due to extended construction cycle times as we navigate these supply constraints. Our teams continue to be diligent and creative in finding solutions and most importantly, delivering high-quality homes to our customers. This includes implementing enhanced scheduling processes, streamlining operations and simplifying production through plan and option rationalization, and expanding and leveraging our strong trade and vendor relationships. While we are hopeful these strategies will help stabilize construction schedules as we move through the year, we're not projecting any change in supply chain conditions in our guidance. We currently expect to deliver between 2,600 and 2,900 closed homes in the first quarter and between 14,000 and 15,000 closed homes for the full year. Given favorable pricing trends in ongoing market strength, we expect the average sales price of our closed homes in 2022 to be at least $600,000 versus $524,000 in 2021. This strong price growth is expected to drive a meaningful improvement in our home closing revenue for the year. From a gross margin perspective, our team’s disciplined focus on managing costs and optimizing our production processes has allowed us to achieve a significant improvement in our profitability. We have also benefited from the realization of acquisition synergies in line or better than expectations since we closed on William Lyon Homes in early 2020 as well as robust pricing power across each of our markets. This execution is evident in the 330 basis point year-over-year improvement in our fourth quarter home closing gross margin to 21.6%. Following this strength, we expect to generate a home closing gross margin of approximately 22% in the first quarter and for the full year, we now expect to deliver a home closing gross margin of at least 23.5% in 2022. This would be up from 20.3% in 2021 and is stronger than our prior guidance provided in October of at least 22%, given further visibility into the strength of our backlog of over 9,100 sold homes. These homes reflect a number of favorable trends, including strong pricing power, acquisition synergies, the ongoing implementation of operational enhancements, improved lumber costs and normalization in the mix of our spec versus built homes. SG&A as a percentage of home closing revenue was 7.8% in the fourth quarter down 180 basis points year-over-year. In 2022, we expect our SG&A to be in the high 8% range, this would represent meaningful leverage over 9.3% in 2021, given strong top-line growth, disciplined cost management and the early benefits of our virtual sales tools. It is worth noting that these tools contributed to a 30 basis point improvement in external broker commissions in 2021 and we anticipate our commission expense will continue to decline as we expand the reach of our digital capabilities, including the use of our online reservation system for both spec and built homes to nearly all of our communities. Turning now to our land portfolio. We ended the year with a robust pipeline of approximately 77,000 owned and controlled homebuilding lots, which represented 5.6 years of total supply. This attractive land portfolio will support community count growth as we move through ‘22 and into 2023. However, given supply chain constraints extended land development timelines are expected to delay some of our community openings. We expect to end the first quarter with approximately 310 to 315 communities as closeouts outpaced new openings. Sequential growth each subsequent quarter is expected to bring ending community count to around 350 by the end of the year. Based on our existing land pipeline and current development timelines, we still expect substantial growth in 2023. I want to point out that going forward, we will provide a guide to ending community count rather than average, which is more consistent with how we manage the business and better reflects the selling and development environment. Before leaving the topic of community count, it is worth noting that one of the ways in which we're driving improved returns is by targeting multi-outlet self-developed communities. Because of this shift our approved land deals in 2021 had nearly 25% more lots than the trailing three-year average, yet lower expected durations due to a significant number of them having more than one outlet per project. Because of these efficiencies these communities drive greater margins and overhead synergies by allowing us to better leverage our field personnel and fixed costs and compete more effectively in the land market. Lastly, I want to provide a brief overview of our capital position and allocation priorities. In 2021, we made significant progress in strengthening our balance sheet and executing our new asset lighter land investment strategies. During the year, we invested $2 billion in land acquisition and development to support our future growth, repurchased 9.9 million shares outstanding for $281 million and deleveraged our balance sheet by nearly 500 basis points to a net debt to capital ratio of 34.1%. In 2022, we expect another strong year of cash flow generation and are targeting homebuilding land acquisition and development of approximately $2.3 billion to $2.4 billion this year. We also expect to further reduce our net debt to capital ratio to the mid-20% range by year-end and will continue to be opportunistic in returning excess capital to shareholders via share repurchases. These actions combined with our strong earnings outlook is expected to drive our return on equity to a new company high in the mid-20% range this year. In closing, I want to thank our teams for all their hard work in 2021. I'm excited about all we have planned in 2022 and look forward to updating you on our progress again next quarter. With that, let's open the call for your questions.

Thank you very much. We have our first question from Carl Reichardt of BTIG. Carl, your line is now open. Please go ahead with your question. Thank you.

Thanks. Good morning, everybody. Thank you for the time today and all the details.

Good morning, Carl.

Hey, Sheryl. I wanted to ask just on mix and going forward mix, with the move-up side being 51% of total orders. As you look at the community count openings, including the sort of multi-outlet thing that we're all talking about in ‘22 and even beyond that. How do you see your mix adjusting over time? Do you expect it to go lower end and then is there any kind of a regional alteration that you're expecting over the next year or two?

Good question, Carl. A couple of things, when I look at the mix of the quarter you saw that we were slightly slanted more than we have been to that move-up, first-second time move-up in active adult. When I look at the new communities, Carl that will be coming on board over the next many quarters, I think you'll see a little bit more pickup in the first-time buyer. I think as we look over time, we see our average sales price moderate a bit as a result of that. When I look at regionally, probably not significant shifts. I mean, Florida will continue to prioritize the active adult certainly the Sarasota and Naples area. When we look at the Carolinas and Georgia, I think you'll see a much greater penetration in the first-time buyer as you will in our California business. One of the most recent shifts in the California business actually the complement of the active adult positions that we've added and they have, as we've expanded the Esplanade brand across the country. They have continued. They have performed quite well.

Thanks, Sheryl. My follow-up is about the improvements on the Canvas. I'm trying to ask this in the right way. If you examine your ultimate goal for build cycle time based on the efficiencies you're improving, and compare it to what your cycle time was before the pandemic, will the pandemic complicate things? What kind of improvement in build time do you expect to achieve from these initiatives? Thanks.

Thank you, Carl. No, it's interesting because we don't have a tremendous amount of data yet on the Canvas, even though we saw about 13%, 14% of our sales in 2021. What I would tell you the early read is an interesting, Carl, I haven't gone back and compared it against pre-pandemic. But if I look at it in real time, compared to the cycle times we're seeing and what I would call our more typical design center build. We've seen a benefit of about 20 days in cycle time on our Canvas packages. So even though the entire kind of portfolio is a little out of whack across in Taylor Morrison and in the industry given the dynamics we have out in the marketplace. We are absolutely seeing a benefit in the Canvas build. I would expect that, if that matures through the organization and obviously, we'll see a considerable ramp up in 2022. We should be able to build on that and then as we get to a more normalized environment again, I would expect that we should retain at least a couple of week cycle time enhancements.

And Carl, this is Lou. Good morning. Just one thing to add to that and another thing, area that we believe we're going to see significant benefits is to sale the start timeframe with Canvas. So that's another added benefit we'll see coming through the pipeline as we continue to roll that out.

Thanks, Lou. Thank you, Sheryl. Appreciate it.

Yeah. You bet. And I just might even add one last comment to it, because Lou you're so right. And when we look at the fourth quarter and we look at some of the closings we lost, we generally lost them in our active adult business specifically Florida is where we saw the greatest shift. But when you compare Canvas or even our normal design center appointments, as we look across the portfolio our options, I know we've chatted about this in the past, but our options in a market like Naples and Sarasota, which is generally all our Esplanade brand or a high majority that's about two times the company average. So when you take that level of complexity out, it's to build with the Canvas packages. Once again, I think it's just about tremendous opportunity for us.

Thank you.

Thank you.

Thanks, Carl.

Our next registered question comes from Matthew Bouley of Barclays. Matthew, please go ahead with your question.

Hey. Good morning. This is Ashley Kim on for Matt today. Congrats on the nice results here. If I could just kind of ask what's giving you incremental confidence to kind of put out that conservatism until you've built up more of that backlog or anything in the pricing or cost outlook that has contributed to that?

of over 9,100 sold homes in our backlog. We have strong visibility to the future margin profile. And in that, our teams, I believe, have built in the correct amount of contingency to get us through with cost increases we're seeing today. And then combine that with the specs that we have under production, which we've increased significantly year-over-year strong visibility to where we think today pricing on those is going to end up being. So we have overall between our specs and our backlog a quite a large portion of our total year's closings some visibility out today.

Yeah. And to your point Lou, compared to last year, like you said, we've doubled our spec inventory and given that those gotten the true benefit of real pricing. We are in a very different position than we were last year. If you think about the 22%, we shared last quarter, I mean the backlog was in a different place, lumber was moving, I mean, a lot of the units are secured for the year already.

Okay. Thanks for that. And then just on my second question, I appreciate that kind of extra color on affordability, given up top, if I could just kind of expand on that topic, has there been any changes in buyer side preferences that you're seeing, any kind of lower square footages or less options in premium, in response to that structuring affordability?

Not yet, to be quite honest about it. We've continued to see strength in our buyers and their behaviors have not really moved. As we discussed in the prepared remarks, the favorable characteristics we've seen with our close customers quarter-after-quarter just didn’t meaningfully change in Q4. As I mentioned, we did see some compression with that first-time buyer, and where we've seen probably a little bit more resistance and probably a larger percentage of folks that pre-qualify and have challenges would be with that first-time buyer. And then when we looked at our entire backlog, our conventional buyers from here are close buyers. Their credit scores are high. Their DTI back ratios are almost right on top of our closed buyers and they have very strong qualifying incomes. We then went ahead and looked and see what would happen if rates move up to 4.5 and honestly, their back ratios still stay very healthy under 40%. And even if we move rates up to 5.5%, they barely go over 40%. A little bit different with FHA buyers as I mentioned, with their back-end ratios would move into the low '50s, but now generally if there's been any pressure on kind of rate. It's really more on the backlog because those are the folks that maybe when they entered into a purchase agreement with us, rates may have been something around 3%, so watching that movement. But I think most notably, as we've done a great deal of surveys with our shoppers to understand how they feel about the moving rate environment. We did a very similar survey back in 2018 and we started comparing the two. We've learned a few things. One, the percentage of shoppers that expect to pay cash is significantly higher and that aligns with what we're seeing in our closings in our backlog, I mean it's moved our cash buyers have moved up more than 50%. The baseline question we asked our shoppers is, how would you feel if rates moved to 5%? And the most interesting stat is only 5% of the hundreds of by shoppers that we've surveyed said that they would stop looking at 5%, and that is much less than half of the responses we got in 2018. They feel like they have a number of different strategies they can deploy—larger down payments, smaller offering, the type of loan. And I think the most surprising stat was the high point of interest rates that would affect their search was very healthy until you got to 7%. I think what we have to remember is with the migration patterns we're seeing from California, New York, New Jersey, the optics on affordability are very, very different. And then when you look at what the average consumer today has an equity in their existing home, this is an advantage for the move-up buyer or active adult buyers. I think we saw a stat yesterday that John Burns quoted that the average equity is $302,000 per household. So when you can bring that to the table it really helps you offset any increase in interest rates.

Thank you. As you said, Sheryl in those high-cost cities people are migrating. These homes are really cheap to them from some of the places are relocating.

They're not full local buyers, right?

Right.

So I hope that helps, actually.

Yeah. All fair points there. And I guess thanks for taking my questions and I'll leave it there. Good luck.

Thank you.

Jay McCanless from Wedbush. You have the next question. Please go ahead.

Hey. Good morning. Thanks for taking my questions. So I guess the first question I had going to the build for rent in. Thank you for the detail there. But I was just wondering, at the end of the prepared comments, you guys talked about doing some bulk sales. Are the bulk sales going to be on balance sheet for Taylor Morrison or is that going to be part of the Christopher Todd joint venture?

No. Good morning, Jay. Yeah. That's really a licensing agreement and kind of leveraging the brand that exists for Christopher Todd, but those will be on balance sheet. Those will be Taylor Morrison assets and will be kind of in control of those disposition decisions for build-to-rent projects.

Yeah. The SFR really won't be engaged with the build-to-rent process.

I think the best way to understand build-to-rent is through the Christopher Todd model, which consists of horizontal apartments and amenitized communities. The single-family rental aspect is simply using our core business to create homes that we might eventually sell to SFR players. This could involve individual homes, specifications, dedicated communities, or specific phases within our master plan. We have a lot of options that we're eager to explore.

Okay. That's what I was kind of getting to is I didn't know if it was going to be a model where you just built an entire community and then sold it, but it sounds like you guys are using it basically that's kind of a tactical play more than anything else. I guess it's best way to think about it. My next question is on the cancellation rate 8%, sounds great. Could you tell us what it was last year and where it was in the third quarter?

Yeah. Sure, Jay. This is Lou. Last year, our fourth quarter, we were at 7.9%. So a lot of us would argue that may be even too low where we're at today. Our financial services team does such a great job of pre-filing our buyers, which makes it a lot easier for us that we don't have to worry about too many cancellations in our business. But you would almost argue we could take some more risks out there, but we're very proud of how low it is.

Yeah, it's great. My last question is regarding your average lot count in the communities you are putting under contract, which I believe you mentioned is up about 25%. I'm curious about how far out you're going to achieve that extra 25%. Are you managing to stay closer to the town, or are you having to sacrifice potential profits to acquire those additional lots? Or are there still locations that are relatively near the core metro areas?

Yeah, Jay. I would suggest that we are still focused on core locations. I always look at the land opportunities in context of the portfolio. So to the extent we need to expand 10% until those areas to get exposure. I would say we're comfortable with that. But by and large, we're focused on core locations. I wouldn't say that we're needing to do those sized deals to reach out, I would say it's a function of the deals that are available to us. And frankly, in some cases, it's a benefit because we have multiple outlets within those communities.

The only thing I was going to add is that if you consider our active adult business generally, those are larger communities that will be added to the portfolio. They will have some impact on the overall size of each asset, but this would be another strategy where we likely have three to five positions within an active adult community.

And just lastly, I'd say that it's part of having the scale that we have, a lot of builders couldn't take down that larger projects. So we're able to get into the core locations as Erik said and get the synergies of having more than one outlet, but many players are not willing to do that bigger project.

And can’t, yeah.

Exactly.

Fair point.

Sounds great. Thanks for taking my questions.

Thank you.

The next question comes from Mike Rehaut of JP Morgan. Mike, please go ahead with your question.

Great. Thanks. Good morning, everyone.

Hey, Mike.

Good morning. I wanted to revisit the gross margin guidance, which is quite encouraging for the full year. Regarding the cadence, I noticed you set a 22% expectation for the first quarter and 23.5% for the full year. I'm trying to understand if we should anticipate a gradual increase over the next three quarters from Q2 to Q4, or if there's a possibility of a significant jump in Q2. The reason I'm asking is due to the 9,000-plus homes in backlog, which suggests strong visibility, potentially leading to a notable increase in the second quarter.

Yeah, Mike. It's a great question. I'd say you're looking at it right. Q2, we had the favorable benefits of lumber reductions. So we'll see some fairly strong margins in Q2. And then as we continue to move through the year, we've been able to stay in front of cost increases going forward. But getting to that where we expect to exit, the exit rate at the end of the year, just based on the averages, you're probably in the low 24s, low to mid-24s.

I mean the one thing we don't have visibility on Mike in the fourth quarter is probably the newest round of rate locks on the lumber because this next lock will really determine your fourth quarter deliveries, but Lou's point absent that they're just going to continue to see that ramp up.

Right. No, that makes sense. I guess secondly, one thing that the whole industry is going through right now, or investors looking at the industry is trying to gauge over the next two or three years, what normalized gross margin could be? Because obviously, you've had a massive amount of gross margin expansion, earnings have doubled and tripled and people are trying to triangulate what's normal. For Taylor Morrison, there's been a lot of structural change on top of the improving housing market and the stronger housing market and positive price cost. I was hoping if you could give a little bit of insight in terms of when you're underwriting land deals today. What type of gross margin is part of that? And also when you look back at gross margins that you generated from 2015 to 2019, it averaged about 18% and that was obviously a period where you're going through a lot of acquisition integration and so forth. I guess it's sort of a two-parter. One, what would that 18% look like today with the improvement in cost structure post-acquisition integration? And secondly, from a land underwriting standpoint, what would the new baseline be, so to speak?

So Mike, a couple of things. Obviously, we're not in a position yet to give margin guidance out beyond 2022. But you said it correctly, when you look in our kind of rearview mirror and you look at the margin profile, we've seen for, what the last five or six years, we've really had a great deal of noise with purchase accounting and things like that. So you know as well as I do kind of the long-term run rate of margin profiles in our industry for the last 20 years and kind of normalized times has been in the 20s. I think structurally it's going to be a little higher than that for the foreseeable future given the supply-demand disconnect. I think so, hard to nail that down. Anything else and then we can talk a little bit about the underwriting.

I would say, Mike, we're finally going to be the beneficiaries of all the hard work our teams have done on the acquisition front from simplification to the various other synergies and the scale that we've achieved through this most recent M&As. On top of that between AV in line, we acquired a lot of lots at fairly strong really good prices. So I think we're really pleased where our lot position is today and our 5.6 years of supply feels really good based on when those lots were secured and contracted.

And Mike, I would add just from an underwriting lands perspective. Look, I've been doing this since 2004. So I would tell you with full emission the last couple of years have been really interesting. With land if it's gone up 30% in the 10% lift in ASP to cover it and we've experienced that and so I think we would say that we've been able to hold our land residual ratios, we’re performing well relative to our underwriting and we're underwriting at current market prices. Where we've been more conservative really is on the paces because that has felt a little bit of a unique environment. As we think about the last couple of years, we've actually engaged in a pretty robust third-party study that's helped us understand really what is a normalization expectation for each one of our markets as we think about historic places, as we think about land coming online. as you think about our positions and so spend a lot of time on that, a lot of time on scenarios and how do we think about some different things playing out relative to underwriting.

It's hard to ignore Erik the kind of generally 20% to 25% reduction in community count in most markets, right. So as those come online, we're going to expect to see paces moderate. So we're really trying to make sure we're ahead of that, Mike.

Great. Thanks so much.

Thank you.

Our next question on the line comes from Alan Ratner of Zelman Associates. Please go ahead, Alan.

Hey. Good morning. Thanks for taking my questions. So first one and nice to hear you on the call Lou. Welcome aboard on the public-facing side. So just on the spec count the doubling that you referenced there, obviously that's, those are homes under construction. And you mentioned the complete number remains very low. Can you talk a little bit about your strategy with those specs in terms of when you're actually releasing those for sale? Are you holding them back until completion or close to completion and just curious because we're hearing similar numbers and similar strategies from other builders, as far as kind of holding specs back and I'm just curious if you've given any thought to the competitive landscape as the year unfolds as you look at specs on the ground today versus potentially available for sale at some point in the future?

Yeah, Alan. Maybe I'll take a first shot at that. I would say our markets each market based on the supply chain environment probably releases on at a slightly different timeframe, depending on when they have better visibility on the costs. So one division may release some more at flat—after slab and other may be closer to frame or close to drywall. So probably varies a little bit across the portfolio, but more importantly as they feel they have strong visibility on one, the cycle time and two the cost structure.

Yeah. I think that's right. And to Lou’s point Alan, I mean it is pretty varied, but I would tell you that there is an overarching company view and working with our divisions that there is a lot of inventory being built and we want to make sure that we get it out to market as quick as we can and we're really makes sense. The supply environment is different in each of our markets. There are some where there's not a lot of inventory under construction across the new homebuilders and there somewhere, it's pretty heavy. So there's a lot of considerations in that. We feel really good. We're not carrying any completed inventory to speak of. I don't think it's 20, 25 units across the portfolio today, which I would tell you is much leaner than we'd like. So we're not going to let these things age. But if we can get them to at least frame drops or lumber drops, it gives us strong visibility on the most significant cost component of the house.

Yeah. And as it relates to our backlog, it's interesting. From 2020, we've seen a 66% increase in the number of our backlog homes that were sold as spec, so you're starting to see it really come through the portfolio at this point in time as we've continued to increase our spec count.

Yeah. And probably the most significant piece that's worth mentioning Alan is, with that pivot, if you think about last year, we had very few specs, everything was 2B built. You saw our sales rates. So in some of our markets where we've really moved up our spec inventory, we've slowed down sales. That's a little bit of what you saw in Q4. And honestly, what you'll see in Q1 as we let those things at least get slabs in the ground where we've pivoted from really holding back and 2B lot at the more affordable level specifically just so that it's both—it’s impacting our sales pace as well as anything.

Yeah. That's kind of what I was getting at Sheryl, so thank you for that. And sounds like a lot of builders are doing the same thing talking about first quarter orders, maybe not seeing that typical seasonal lift that you otherwise would, given kind of the timing of each of those specs, a little bit in getting further along in the construction process. Second question on the mortgage side, and thank you for all of the information on the surveys, et cetera. I'm curious, now that the move-up piece of your business has grown as a piece of the pie at least. At least for the time being. When you look at your either buyers or prospective buyers and I think the biggest difference now perhaps versus earlier on in the cycle when rates were hopping around is the vast majority of home buyers at this point have refinanced at a much lower mortgage rate and if you look at the overall universe of mortgage holders 70% are locked in below a 4% rate. So while affordability might still be attractive. Just thinking about turnover there is that risk that a buyer is going to be less willing or perhaps to tougher pill to swallow to give up a low rate when the newer rate is going to be above that. So have you looked at that at all in the surveys that at all in terms of the willingness for the buyer to give up that low rate, if the newer rate is well above kind of where they're locked in at?

Yeah. That's the survey that I mentioned, Alan, we've actually spent a great deal of time understanding, kind of our shoppers' views on what's motivating them to relocate. We obviously saw a different level of motivations back right after the pandemic started than what we're seeing today. And you're right, people have very low interest rates, but you can't forget that $300,000 on average. And generally when we think about the reasons they're moving, they have a whole different set of motivations today, when you look at the move-up buyer, the house isn't exactly—they need additional flex spaces, added bedroom counts, moving closer to grandchildren, there's all kinds of motivations, but honestly, we are seeing even in our move-up buyers, the first inventory to go is generally the largest. So it's been quite interesting. Now the motivations on the first-time buyer, a little bit different and that's where we're seeing, like I said, some compression. So we're really making sure that the specifications on those houses are really targeted to market. So it doesn't take people out of the buying opportunity. But interestingly enough, when you look at what they're locked in today, it's really being offset by the amount of equity they have in their home.

Thank you. As you said, Sheryl in those high-cost cities people are migrating. These homes are really cheap to them from some of the places are relocating.

They're not—it's full local buyers, right?

Right.

So I hope that helps, actually.

Yeah. All fair points there. And I guess thanks for taking my questions and I'll leave it there. Good luck.

Thank you.

Truman Patterson from Wolfe Research, you have the next question. Please go ahead.

This is Paul Przybylski. I wanted to touch on something you mentioned regarding the lack of trade down in square footage. You noted that the move-up buyer is leaning towards larger homes. Considering your range of floor plans, where do you see the consumer currently positioned? How much flexibility do they have to downgrade before you need to reassess? Also, do your smaller floor plans maintain the same profit margins as the larger ones?

Yes, they do. Let me address this in reverse order. Generally, square footage isn't the primary factor affecting the margin; it's largely about how the land was acquired. When I examine the portfolio as a whole, we do notice some reductions with the added specs in square footage. Our plans that we take to market are typically more affordable options. We cannot ignore the changes we've observed in pricing and interest rates. We've conducted substantial testing on buyers who purchased a year ago compared to those interested today, particularly with potential 4% interest rates, and there is indeed a significant shift. What's intriguing is that when we analyze our backlog, these buyers are managing to absorb the changes without considerable alterations in their back-end ratios. Part of this is due to those buyers having higher down payments and better financial standings than last year. While I hate to sound repetitive, it’s clear that when we assess our backlog and the current shoppers, many are not yet ready to make decisions on moving up. We are observing a slight compression, yet even with this, first-time buyers find themselves pushed towards the higher end of back-end ratios, but still within their affordability ranges. What stands out to me is that when we break down our backlog, the average loan amount for our government FHA buyers is actually more than that of our conventional buyers, largely because they have the option of a lower 3% down payment. We keep a close eye on the first-time buyers since their income growth isn't keeping pace with the combined effects of rising rates and price appreciation.

Okay. And then I guess as rates have moved higher this year, if you've seen any conservatism enter the land market from either you or your peers?

As Erik mentioned, we have been—everybody's feature, we have been very discerning in our acquisition strategy.

Yeah. I think it all comes around to scenarios, right, so what if home prices take a step backward what was that due to our underwriting. What does that mean relative to the affordability of that land? What does it mean to our metrics? So yeah, I can tell you it's a conversation as part of every land that we underwrite and it really comes by way of the scenarios.

Thank you. I appreciate it.

Yeah, there is usually a drag six to nine month drag. And I think as I mentioned earlier, we're in a good position where we don't have to chase a lot of land because we do have a strong land bank in front of us. So we're not chasing those deals that look to us a little bit too high in costs. And we are seeing some transactions that we wouldn't participate in.

All right. I appreciate that. Thank you.

Thank you.

Our next registered question comes from Mike Dahl of RBC Capital. Mike, your line is now open.

Hey, thanks for taking my question.

Hey, good morning.

So I guess just on land, you mentioned that you were targeting that 5.6 years of inventory supply, which is obviously a good buffer. How is that comparing relative to your peers? And if you were to throw in the cycle timelines and maybe some development lead times, where do you guys stand in terms of your peers right now?

Yeah. I think one of the things that in terms of positioning is we are more focused on the controlled stable of lots that we secured through those acquisitions. And given the timing and the lot position we have at 5.6 years, it allows us to be more opportunistic versus transactional in a rapidly changing cost environment. So we feel really good about our positioning as compared to our peers.

Perfect. Makes sense.

And we are seeing others that may be buying at auction. We are being a little bit more precise in our buying.

Perfect. Appreciate it.

Thank you.

Our next question comes from Ashley Kim of Barclays. Ashley, please go ahead with your question.

Thanks for taking my question.

Hey, Ashley.

I was just wondering how you're looking at your share count for 2022 and then dividend payouts, if there's any changes we should expect there.

Sure. We currently expect our share count to be around 124 million at year-end, that doesn't imply a lot of share buybacks. We've been engaged in buybacks, but we might take a little bit of a break while we invest back into the business and look at other deals that may come along.

Okay. Thank you.

Thank you. That concludes our question-and-answer session. I would like to turn the conference back over to Sheryl Palmer for any closing remarks.

Thank you all for joining us today. I look forward to updating you at the end of the first quarter.