Taylor Morrison Home Corp Q1 FY2023 Earnings Call

Hello, everyone, Good morning, and welcome to Taylor Morrison's First Quarter 2023 Earnings Conference Call. Currently, all participants are in listen mode only. 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.

Thank you. And good morning, everyone. We appreciate you joining us today. Before we begin, let me remind you that this call, including the question-and-answer session, will include forward-looking statements that are subject to the Safe Harbor statement for forward-looking information that you can review in our earnings release on the Investor Relations portion of our website at 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, I will turn the call over to our Chairman and Chief Executive Officer, Sheryl Palmer.

Thank you, Mackenzie, and good morning everyone. Joining me is Lou Steffens, our Chief Financial Officer; and Erik Heuser, our Chief Corporate Operations Officer. Also with us is Curt VanHyfte, our West Area President. As you may have seen in this morning's earning release, Lou will be stepping down from his CFO responsibilities in order to attend to family matters that require him to relocate out of Arizona. While this move precludes him from continuing with the demanding requirements of the CFO position, Lou will remain an important member of our leadership team as he shifts into the role of EVP of Strategic and Operational Initiatives, where he will drive our continuous focus on enhanced processes and performance. In his place, Curt will step into the role of interim CFO effective this Monday, May 1. Curt currently oversees our West Region and has nearly 30 years of homebuilding experience, as both a finance leader and field operator from roles in corporate finance and as a division and regional president for several national homebuilders, an ideal background that maintains the strong operational and finance cohesion that we specifically look for and have benefited from under Lou's tenure. At the same time, as we commence a search for a permanent successor, we are incredibly grateful and confident in Curt's willingness and ability to lead our finance teams. We are also thankful for Lou's meaningful contributions as CFO during his time in Arizona and look forward to his continued leadership while most importantly wishing his family all the best. Now let's dive into our call. As always, I will share our quarterly highlights and update on the market and our strategic priorities. After my remarks, Erik will discuss our land portfolio and investment approach, while Lou will review our financial results and guidance metrics. In the first quarter, I am pleased to report that our results outperformed our expectations across all key metrics, due to our team's strong execution and stabilizing market dynamics. We delivered 2,541 homes at a robust home-closings gross margin of 23.9% and an efficient SG&A ratio of just 9.9%. Most notably, this gross margin was up 80 basis points year-over-year due to our ongoing focus on operational enhancements and our balanced approach to rebuilt and spec home sales. Despite the modest reduction in total revenue, our focus on improving operating margins through strategic efficiencies allowed us to deliver a more than 20% increase in diluted earnings to $1.74 per share and a 32% growth in our book value to $44 per share. These strong results drove a nearly 500 basis point increase in our return on equity to 24%. We ended the quarter with approximately $2 billion in total liquidity, while our homebuilding net debt to capital ratio declined further to an all-time low of 21%, providing us with significant financial flexibility to invest in our business to drive returns as we move forward. As I shared on our last call in February, we experienced a rebound in sales activity and shoppers' sentiment during the early weeks of the spring selling season. The positive trends continued to accelerate in March, following typical seasonal patterns, despite the uncertainties facing the market. During the quarter our gross sales orders improved to a healthy monthly pace of 3.4 per community, the highest level since the third quarter of 2021, while our cancellation rate declined to more normalized levels at 14% of gross orders. This drove our monthly net sales pace to 2.9 per community, as compared to 1.9 in the fourth quarter and 3.1 a year ago. This momentum has carried through the first three weeks of April with our sales running at a pace of approximately 3.1 net orders per community. Leading indicators, including sales traffic, mortgage pre-qualifications, and digital home reservations, which remained our top conversion source, at a rate of 40% in the first quarter, are also encouraging. Recognizing the interest rate volatility and banking sector turmoil that unfolded during the latter part of the quarter, I am very pleased with the resiliency of our sales trends, highlighting the significant need for new construction in our markets as well as the financial health of our diverse consumer groups. To that point, our buyers financed by Taylor Morrison Home Funding, whose capture rate improved to 82%, had an average credit score of 756 and provided an average down payment of 25% in the first quarter. Both metrics were stronger than a year ago and above industry averages, even with 38% of those consumers being first-time homebuyers. The toughness of our buyers is also evident in the size of our deposits, which averaged $66,000, or about 10% per home for our customers in backlog, helping to minimize our cancellation risk. When I look across our portfolio, the first quarter stabilization was evident across nearly all of our markets. Strength was most pronounced in our East Region, led by all of our markets in Florida and Charlotte. Our Central Region was somewhat mixed, with strong improvement in Dallas supported by stabilization in Phoenix and Austin, while Houston was a notable outlier although April trends have improved there as well. And lastly, in the West, all of our markets showed positive signs during the quarter, with the exception of Portland. Across the country, we benefit from the diversification of our buyer groups, quality of our locations, and financial health of our consumers, each of which is an intentional element of our strategy that we believe enables us to produce long-term value through the ebbs and flows of housing cycles. Parsing the trends by consumer group, sales were strongest among move-up buyers, which accounted for nearly half of our net orders, led by our second-time move-up category, where both sales and pace were up firmly year-over-year. This was followed by our entry-level segment, where first-time buyer demand for spec homes stabilized with the use of our strategic incentive programs, while our resort lifestyle segment experienced a pickup as we moved through the quarter. Driving our sales, our teams continue to leverage our various pricing tools and emphasize the value of finance as a sales tool with targeted incentive programs, including the ability to lock-in interest rates for up to 12 months on to-be-built homes and take advantage of below-market interest rates for spec homes. Equipped with these compelling mortgage offers, as well as our innovative digital sales capabilities and other marketing tools, our teams are continually adjusting to market conditions to drive optimal community performance. As demand has improved, we have begun to pull back on incentives in many of our communities and even raised pricing in some, reinforcing shoppers' sense of urgency and further solidifying the value of our backlog. The success of this strategic approach is evident in the strength of our recent gross margin trends, which have outperformed on both an absolute and year-over-year basis. We believe this outperformance reflects a number of factors, including our ongoing focus on capturing operational enhancements across our business, the underlying value of our prime land portfolio, and our favorable mix of to-be-built and spec home sales. To the latter point, we adjust our mix on a community-by-community basis depending mainly on the targeted consumer group and price point. Beginning in the fourth quarter of 2022, the gross margin differential between the two has reverted to historical norms in which to-be-built margins have exceeded spec margins by at least several hundred basis points due to higher-margin option and lot premium revenue earned when discerning buyers built their dream home and higher incentives typically required when selling spec inventory. In the first quarter, this spread amounted to nearly 400 basis points, reversing the temporary margin outperformance on spec sales in much of 2021 and 2022 when demand for move-in-ready homes significantly outpaced supply. While quick move-in homes remain attractive, especially in lower price points, only about 30% of our shoppers in the first quarter said they are looking for a home available within 30 to 60 days, while the vast majority indicated that a quick closing is either not an important consideration or that they prefer to fully personalize their home. This is consistent with preferences in 2020 and prior, as the increase in quick move-in demand over the last two years has more recently normalized back to historic averages, based on our comprehensive survey data. While our actual mix of spec sales has been running roughly two times higher at about 60%, given our intentional shift to more spec sales to better manage production, we believe these insights continue to support the balanced mix of our overall portfolio. As we look ahead, from a margin perspective, based on the mix of deliveries, we expect our home closings gross margin to be between 23% to 23.5% in the second quarter and approximately 23% for the full year. This assumes a greater proportion of spec home closings in the second half. On the construction side of the business, we remain focused on driving tighter production schedules, pushing ahead on cost rationalization with our suppliers and trade partners, and continuing to refine our product and option offerings for ongoing value engineering and cycle time efficiencies. In many of our markets, we are experiencing some relief in the early stages of the construction cycle, driven by a return to normalized product lead times and improved labor availability in some categories. However, the back end of the construction cycle remains constrained as still tight labor capacity among those trades continues to pressure the industry. This mirrors the cost side of the equation, where the realization of aggregate savings will be gradual. Despite the headwinds, we are driving efficiencies through a number of initiatives, which will ultimately allow us to carry less work in process inventory on our balance sheet, thereby driving enhanced inventory turns, increased production potential, and improved returns. For example, we have streamlined our floor plan library by more than 50% in the last two years and realized a roughly 50-day savings from sale to construction start for homes utilizing our popular option packages compared to traditional design studio starts. These are just two ways in which we are driving reduced costs and improved revenue opportunities. To wrap up, let me say that we are greatly encouraged by the recent improvement in sales and consumer sentiment. We also recognize the uncertainties surrounding interest rates and economic conditions. Given our balanced portfolio, scale, and financial strength, we believe we are well-positioned to navigate near-term market volatility while focusing on our long-term approach to disciplined capital allocation and market positioning. Our leadership and field teams are accustomed to operating within these dynamic conditions, and our playbook will continue to emphasize smart growth, operational efficiencies, and an exceptional customer experience. Now let me turn the call to Erik to share more about our land strategy.

Thanks, Sheryl. And good morning, everyone. I will share an update on our attractive land bank and our disciplined investment approach, which remains highly opportunistic. Last year, we quickly moderated our land spend as housing market conditions began to turn, sharpening our already stringent approach to underwriting and capital allocation. With a strong pipeline of lots already owned and controlled, we were in the fortunate position of being able to reduce our pace of investment while still maintaining strong market positioning. Today, with housing showing some signs of stabilization but the macroeconomic outlook remaining highly uncertain, we continue to be prudent and patient in our investment decisions. This includes re-underwriting every phase of land development, lot takedown, and deal closing to ensure each dollar invested continues to reflect market conditions and our stress-tested return thresholds. In the first quarter, we spent $321 million on homebuilding land acquisition and development, of which 68% was development-related. This was down from $394 million in the first quarter of 2022, when just over 50% of spend was dedicated to development. Also of note, we incurred a modest $1 million in walkaway expenses related to deals that no longer met our requirements during the quarter. As we look ahead, we have significant financial flexibility to take advantage of market opportunities. At this time, we continue to expect our total land spend this year to be similar to 2022 at around $1.6 billion, driven mainly by development, although our ultimate investment will depend on market conditions and deal flow. At quarter end, we owned and controlled approximately 73,000 homebuilding lots, representing 5.9 years of total supply, with 42% of these lots controlled via options and other off-balance-sheet structures. Our supply of owned lots was just 3.4 years. Each of these metrics remained within our targeted ranges. When underwriting new deals, we evaluate cost of capital, risk mitigation, and expected returns to determine the optimal financing structure for each project, driving a balanced portfolio that we believe optimizes long-term performance. Overall, we remain pleased with the composition and basis of our well-underwritten capital-efficient lot portfolio that is concentrated in prime core submarkets. Approximately 55% of our owned lot supply was negotiated in 2020 or earlier, providing an attractive historic cost basis that we expect will enhance our relative gross margin profile going forward. With that, I will turn the call to Lou.

Thanks, Erik. And good morning, everyone. I will review our financial results and provide detailed guidance for the second quarter and introduce our expanded outlook for the full year. Before I dive in, I'll first address this morning's announcement. I'm incredibly grateful for Sheryl and the Board's understanding as I transition into this new role, which provides me with the flexibility I need to address personal family matters. The team at Taylor Morrison has been my extended family for the last 16 years, and I'm deeply committed to our continued success. By focusing on our strategic and operational initiatives, I will remain engaged in the areas of the business where we can continue to have a significant opportunity to further capitalize on enhanced scale and integration successes. I will also closely support Curt and know he will be a terrific leader and advocate for our teams in the CFO seat. Thank you all for your understanding and your support of Taylor Morrison. With that, let's turn to the exceptional performance our teams delivered in the first quarter. We generated $1.74 of earnings per diluted share. Compared to the first quarter of 2022, this was up 21% driven primarily by improvement in our home closings gross margin, greater financial services profitability, and a 10% lower diluted share count. We delivered 2,541 homes at an average closing price of $635,000, which generated home closings revenue of $1.6 billion. Compared to our guidance, closings benefited from greater spec homes sold and closed during the quarter, while the average sales price was as expected. During the quarter, we accelerated our starts volume to approximately 2,500 homes, given the improvement in sales activity and our focus on rebuilding inventory levels to maintain approximately one finished spec home per community. This equals 2.6 starts per community per month, up from 1.6 in the prior quarter, but still below 4.2 a year ago. As a result, at quarter end, we had approximately 7,700 homes under production, including approximately 2,200 specs, of which only about 230 are still less than 1 per community were finished. Based on our homes under construction and assuming no meaningful change in cycle times, we currently expect to deliver between 2,600 to 2,700 homes in the second quarter and between 10,000 to 11,000 homes for the full year. From a pricing perspective, we expect the average closing price of our deliveries to be between $630,000 to $635,000 in the second quarter and around $625,000 for the full year. Turning to margins, our home closing gross margin improved 80 basis points to 23.9% from 23.1% a year ago. This was ahead of our prior guidance due primarily to stronger net pricing and fewer concessions on homes sold in prior quarters than originally expected. As Sheryl described, based on the mix of expected deliveries and strength of our to-be-built margins, we expect our second-quarter home closing gross margin to be between 23% to 23.5%. With a greater percentage of spec home deliveries anticipated in the second half, we anticipate our home closings gross margin to be approximately 23% for the full year. SG&A as a percentage of home closings revenue increased 30 basis points to 9.9% from last year's record first-quarter low of 9.6%, despite the decline in revenue and closings. We are increasingly benefiting from the efficiencies and cost savings from our innovative digital sales capabilities and other sales and marketing initiatives that we expect will further improve our cost structure compared to historic norms. For the year, we are forecasting an SG&A ratio to be in the high 9% range. Shifting to sales, our net orders in the quarter were down 7% year-over-year to 2,854 homes. This decline was driven by a 7% reduction in our monthly net sales pace to 2.9 per community as higher cancellations offset year-over-year improvement in our gross sales pace to 3.4 per community, while our ending community count was flat at 324 outlets. As Sheryl noted, demand trends improved throughout the quarter and sales have been running at a pace of approximately 3.1 net orders per community in the first three weeks of April. From a community count perspective, we expect our ending outlets to be roughly flat from the first quarter between 320 to 325 in the second quarter and for the full year. To wrap up, we generated $348 million of cash flow from operations during the quarter and ended with total liquidity of approximately $2 billion. This included $878 million of unrestricted cash and $1.1 billion of available capacity on our revolving credit facilities, which were undrawn outside of normal letters of credit. Our net debt to capitalization ratio declined to an all-time low of 21% as compared to 24% in the prior quarter and 35.7% a year ago. As a reminder, we lowered our gross debt outstanding by $710 million in 2022, which reduced our annual capitalized interest burden by approximately $40 million to the benefit of our future gross margins. Our next debt maturity is in March of 2024, which we have ample cash on hand to address, after which our next maturity will be in 2027. Overall, our strong capital position leaves us well-equipped to take advantage of investment opportunities as they arise, while also remaining balanced in our approach to share repurchases and debt management, all with the focus on driving optimal long-term returns for our shareholders. Now, I'll turn the call back over to Sheryl.

Thank you, Lou. Before ending today's call, I want to briefly elaborate on one of the critical long-term trends driving our focus as an organization. In 2022, ethnically diverse consumers increased to 61% of our homebuyers from just 45% in 2020, a significant shift that we expect will continue to evolve as younger, more racially diverse cohorts enter the prime homebuying years. With multicultural population growth reshaping homebuying demographics, we are responding to the needs of these communities with our land strategy and by incorporating diverse design principles, increased pricing and sales transparency, and functional and aesthetic preferences of our growth audiences. I shared more of our focus on these important shifts in my recent shareholder letter, which you can find on our website and look forward to continuing to update you on our evolving strategy to thoughtfully cater to our consumer base. In closing, I'd like to thank our Taylor Morrison team for another impressive quarter. The team is second to none and I'm so appreciative of their teamwork and commitment. Thank you all. With that, let's open the call to your questions. Operator, please provide our participants with instructions.

Our first question comes from Truman Patterson from Wolfe Research. Truman, your line is now open. Please go ahead.

Good morning. Actually, this is Paul Przybylski. I guess the first question, what percent of your communities have seen pricing come off the bottom? And then what percent of your communities would you actually be seeing incremental incentives and what markets would those really be in?

As far as the number of communities that we've seen adjustments, I would say those adjustments would be both pricing adjustments as well as a reduction in incentives. It's just about over 50% of our communities. And the second question, I missed part of what you said, do you mind repeating?

Yes, I guess, what markets are you seeing continuing to see incremental incentives?

Incremental incentives. So when I look across the organization, probably the place that we've seen the greatest incentives have been in Portland, Houston earlier in the quarter, and Denver earlier in the quarter. Besides that, we have seen strength across really the rest of the portfolio. When I look at our sales in the quarter, we saw Charlotte, Tampa performing well year-over-year in sales. Dallas had its best quarter within two years, and we've seen some nice recovery from places like Austin and Phoenix that I think you know were fairly stressed last year.

Okay. I appreciate the spec build-to-order margin color. Is that in any way being colored by, let's call it, second half of last year cancellations or of customized homes that you may have to be discounting more than you would a normal spec and so just kind of a temporary differential.

No, I don't think so, Paul. In fact, I would tell you that we are returning to what I would say the old norms. I mean late 2021 and early 2022, I think that was the exception and that was really because we continue to see, as you know, back then something like 1% a month price appreciation and builders were holding back sales until those homes were next to complete, where the to-be-built homes didn't get the benefit of that price appreciation because they may have been in backlog eight to 12 months. They also, unfortunately, got the added cost. But interestingly in that, if I look at Q1, Paul, our to-be-built margins were up about 480 basis points year-over-year and our quick closings were down over 500, that's more of the historic norm.

Okay. And finally, demand is obviously better than expected in the first quarter. But what are you hearing from the field for buyers that are qualified, what is actually keeping them on the sideline for prospects, I should say?

It's interesting to note that consumers are behaving a bit differently across the country. In several of our markets, we've heard from the field that as builders become more aggressive with pricing and discounts, it creates an unsettling feeling among consumers. When buyers think prices are still dropping, they lack a strong motivation to make a purchase. We saw a similar trend with interest rates. The ongoing momentum we've experienced can be attributed to the stabilization of prices and interest rates. In many areas, consumers are aware that prices might increase next weekend. When I assess cancellations versus sales, it mainly relates to financial capacity, with most cancellations coming from first-time buyers. This situation aligns with what's keeping them on the sidelines. However, the demand momentum indicated by our year-over-year gross sales demonstrates that we are seeing those individuals gradually returning to the market.

Our next question comes from Carl Reichardt from BTIG. Carl, your line is now open. Please go ahead.

Thanks. Good morning, everyone. Lou, I wish you all the best in your new role. Sheryl, to follow up on Paul's question, the narrative has been that move-up customers, due to their locked rates, are likely to remain in their current positions, but we're observing a significant improvement in that area. I'm curious about your thoughts on the idea that rate locks are preventing people from entering the market. Have you begun to notice a shift among buyers? After COVID, we witnessed a lot of migration between states. Are we starting to see more local customers stay within their markets and move up? I'm interested in how the move-up market is thriving despite the narratives we've been discussing for the past couple of years.

It's such an important topic. I appreciate the question, Carl. You're right. The narrative has been something like 85% of the mortgages across the country are sitting there with a rate less than 5%. And where rates have been, certainly the back half of last year where they were at some point actually got to 8%. Along with what has happened on the pricing appreciation side, that was a tough touch. Now that rates have settled, and I know we've seen some movement week over week, but now that rates have settled, I would say in that low 6% range, the ability for our consumers to lock down their rate to something that is more consistent with what they've had, I think it's very different than what we saw last year. Another stat that I think is just so interesting is that when we look at our current backlog, 45% of them own a home today and are buying a new one. The number of folks that actually owned a home, but are probably already sold their home and are sitting waiting for their next home to be complete is probably significantly higher than that. And out of that 45%, probably 65% or so will be listing and closing on their home before they buy the new one, and 30% to 40% of those folks will retain the option of keeping that home and maybe using it as a rental before purchasing. So I think because of where rates have settled, a lot of that narrative is honestly going away.

And maybe, Sheryl, regarding the migration aspect, from a broader perspective and then a more specific one. Carl, if you examine our footprint, we have a strong presence. Currently, Florida is experiencing over $400,000 in net migration, Texas is seeing $350,000, North Carolina has over $100,000, and Arizona is at about $100,000. This illustrates a specific trend within a larger context. For instance, in Naples, where we operate, a significant 56% of our buyers are moving from out of state. In contrast, in Sacramento, California, a staggering 96% of buyers are local. This signals a similar demographic but reveals distinct migration behaviors.

So the post-COVID in-migration activity has waned, but the traditional in-migration activity that we've historically seen in this business continues. I guess that's the best way to summarize that.

Okay. Thank you. And then the second question is on community count. Post the land deal community count, I think it's way below a little bit, but generally been relatively flat and sell-through is part of that. But I'm curious when you look at your land portfolio now, when you would expect the community count to begin to ramp more meaningfully? If it's not going to be '23, is '24 more of an inflection year or is there something we should wait for longer? Thanks.

Yes, good question, Carl. A couple of things are affecting our outlets post William Lyon and some strategic initiatives. One we've talked about the last few quarters that Texas is in the middle of a strategic change, where we had a large percentage of our outlets that were enhanced plans on the same lot size as many other builders. So slowly, they've been reducing our exposure to those master plans and have more wholly-owned communities that drive a little bit higher pace. So that transition has impacted negatively our outlets a bit. We've talked also about especially when Q4, we had the tougher sales environment, our teams have made a shift to open our communities when models and entrances are complete. A handful of outlets later this year that we had expected are being impacted by our Q3 and Q4 walkaways, but we are still pleased with the land portfolio having 73,000 lots that we own and control will provide us an opportunity for future outlet growth. It's just a bit of timing based on some of those items I mentioned. Also, the weather we've seen in California and the hurricanes in Florida have delayed some of our more recent outlets opening due to transformers and other delays.

In summary, Lou, we initially expected more growth this year, but several factors have pushed some of that growth into next year. The straightforward answer, Carl, is that you will begin to notice an increase as we progress through next year. Although this year we will likely see some changes, as you mentioned, we've also sold through more communities than we expected. You'll start to notice that increase as we move into next year.

I know all about the weather in California. I appreciate it all. Thanks so much.

Thanks, Carl.

Our next question is from Mike Rehaut from JPMorgan. Mike, your line is now open. Please go ahead.

Hi, good morning. Doug Wardlaw on for Mike. To the extent that demand continues on its trend, how does your land strategy change? And also in the event that the macro environment stabilizes and demand stays robust going into 2024, do you anticipate a material change in your land strategy long term?

Yes, it's a good question, Doug. As a reminder, we've been investing prudently. We continue to invest, as Lou suggested, we've got 73,000 lots, 5.9 years. So we feel real good about where we sit today and we've used the word opportunistic quite a bit in the last number of quarters. But to your point, I think as the environment stabilizes, we will be looking to lean in a bit more. We're really focused on where we can add positions that are accretive to the near-term community count growth. So I do think, to your point, as things continue to stabilize, as our confidence grows and as the crystal ball gets a little clearer, we will start leaning in a bit more.

Got it. Great. And then I guess switching gears a little bit, kind of going back to the incentive pricing question. Your strategy moving forward again in the event that demand stays where it is and there’s not a drop-off at any point throughout the year. In some areas where there are more significant increases in incentives or more base price cuts, how are you planning to approach that as it’s going to be a community-by-community basis, or just kind of a national strategy there? And in addition to that, regionally, has demand kind of surprised you anywhere based on the levels we’ve seen recently?

Yes. I would tell you that on the pricing side, those decisions really do need to happen locally because you really have to understand the competitive environment and supply environment. But I think as we've also shared, price cuts become our last strategic resort because we are able to help consumers in such a greater way by putting those dollars towards finance incentives. About 88% of our closings in the first quarter had assistance with discount points to help them get to that closing table. The ratio as you know is 3:4:1, so it's very meaningful. There were some markets late last year that we had to implement some repricing, but I'd say today that is actually not one of the tools we're using too often. And the second part of the question is where we're seeing greater strength?

Also, areas where there's been a strong recovery from kind of the bottom as we've seen towards the end of 2022.

Yes. I would really point to Phoenix and Austin, probably because they ramped up the fastest and the most on the pricing curve. In Austin, the growth continues to be really quite strong, but with cancellations continuing to be a little higher than I would say the company average. In Phoenix, the growth on the net is seeing that pull through, and we're also seeing pricing strength. Florida continues to be strong, and maybe the other call-out would be in Charlotte. We’ve seen significant strength in Charlotte, which is one of the leaders. Lastly, the Bay Area, has exhibited one of our strongest paces in the country in the first quarter. Almost across the board, we are seeing pockets of strength in most of our markets.

I don't know how you feel, Sheryl, but one of the nice surprises there was a lot of concern last year about excess inventory getting absorbed, and it looks like you all have done a good job absorbing that inventory, which is really key.

No, I think that's important because we were quite concerned about the new home market due to the cancellations and the number of starts. However, we haven't observed any issues in the resale market, so we continue to be encouraged.

Our next question comes from Alan Ratner from Zelman and Associates. Alan, your line is now open. Please go ahead.

Good morning. Thanks as always for all the great information so far. I thought the spec to-be-built commentary and margins, was really interesting. I just wanted to dig into that a little bit more, because your guidance on margin for the remainder of the year implies a bit of a drift lower. And I think you kind of alluded to, that's more of a mix impact from higher spec closings. But I'm just curious if you could kind of detail specifically what's embedded in that guidance as far as pricing and costs, specifically?

Yes. Really good question, Alan, good morning. I would tell you a couple of things. One, we still have a lot of our strong backlog closed or sold earlier last year, that is starting to come down. As we've increased our spec percentage, you'll see more of those coming through in the latter part of the year that generally are a little bit lower price, where we've had very strong to-be-built home sales in the last couple of quarters. Those generally have a little bit longer cycle time. So you'll see some of those benefits through the remainder of the year, but they're generally taking a little bit longer than the average spec that we build. We are starting to see some of those already after we start them as to-be-built, moving into early next year, which will give us some pricing strength starting at the beginning of next year. I'd really wrap it all up and say that some of this is going to come down to what we see with cycle times for the remainder of the year. We had our calls with our teams last week, and generally overall, very positive. But so far, we've just seen from days to a couple of weeks on the front end and we’re not seeing that still come through the back end, but you'd expect after a couple of quarters of lower starts in the industry that those will give us some opportunities later in the year, which we're not counting on. If we can pull some of that higher margin backlog into this year, we may have some opportunities, but we're not counting on that today.

Got it. But just on that point, you're not embedding any additional incentives or anything needed to move those specs or any meaningful cost changes. It's really just kind of flowing through the current environment, and any upside or downside is going to be more timing-related to the cycle times?

A little bit on the units that we sold in the middle of last or early last year. It's probably a little bit embedded.

Yes, there's probably a little bit. But that was the nice thing this quarter on our order revenues. We didn't have the noise that we've had the last couple of quarters because we haven't had to go back to previous backlog and discount as much to get them to the finish line. To me, that's a sign of strength of the market improving. So from that standpoint, we've been very pleased. The rest of it, the specs, we're showing what we think we need to sell them today. So if the market continues to firm up, we hope there are opportunities there.

And then I think on the interest rate question, on the cost side of the interest rate, Alan, it's just not costing us as much as it was a couple of quarters ago to help customers get their mortgage in place. We have to see if we maintain that spread, but I think we've assumed lower and not going back to where we were, but we did need to see what happens to interest rates.

Got it. That's helpful. On a similar note, I just want to make sure I'm understanding the strategy correctly here. You, as well as a lot of other builders last year, ramped your spec starts and I think that strategy is paying dividends here just based on how tight the resale market is and where demand has trended. Your 60% specs, which is higher than you've historically been, it sounds like you're seeing improving demand on to-be-built and the margin differential is returning to historical norms. So as you think about your start pace here going forward, are you replacing spec starts at the pace you're selling through them or are you looking to over the course of this year, get back to a more historical mix of to-be-built and spec, which I would imagine would require starting fewer spec homes?

Yes, I would say we definitely want to replace our specs as we sell them. In the last couple of quarters, we've said we wanted to get our starts back to our sales pace, this quarter was a little bit short at the 2.6%, but part of that is, as you mentioned, we've sold a few more to-be-built. We went up from 500 basis points on our to-be-built sales this quarter from Q4. It takes a little bit longer from the sale to start these. Although we have also made pretty significant progress in reducing our sale-to-start times as more of our homes go through our Canvas program. Overall, I think that we're still in the ramp-up process of getting a few more starts in the ground than we've been tracking, but we still like specs; it's been a good balance for us more recently.

Yes. I think the key for us, Alan, is going to be aligning our specs to consumer demand. I mean, I know it sounds so obvious, but we're seeing the majority of that demand at the first-time buyer. It's interesting that when we're looking at some of the research for the quarter, one in four of our shoppers said they would prefer a spec, and that they can be motivated by a spec at a high percentage. The macro environment should also continue to impact our strategy. Obviously, if we can have to-be-built properties where we're getting that margin enhancement, we will do that. But having said that, even though historically something like 7% to 10% of our consumers would buy a spec due to incentives, today that number is closer to 40% because of the environment we've been operating in. But like Lou said, we're going to continue to start specs as we replace them. But at the same time, we want to ramp up our production and continue to grow our to-be-built business.

Maybe it’s worth mentioning that our teams have made huge strides in trying to improve our closing cadence. Having those specs available has really helped. Based on our guidance, we hope to have close to half of our year closed in the first half, which is the best we've done since before 2000, and it really helps from our trade base perspective in terms of having visibility and consistency.

Our next question comes from Matthew Bouley from Barclays. Matthew, your line is now open. Please go ahead.

Good morning. You have Elizabeth on for Matt today. I know that rate lock-ins have been a focus for your incentive strategy. Is that still what people are the most responsive to? Or are there any other types of incentives that have been getting people over the finish line? And generally, is there a clearing rate or a specific number that you're seeing people particularly responsive to?

Yes. Good question. I would say the buy-downs are absolutely the preference for most of our buyers across the country. Second, certainly for our active adult buyers would be maybe option incentives, where some of those buyers tend to use more cash or take smaller loans or don't plan on holding them as long. As far as the clearing price, I think that's actually the best part of the news. As the consumer has really adjusted to this new rate environment, they no longer believe that rates are going to return to 3% or 4%. When you look at our note rate for the quarter, it was something around 5.5%, and that's generally where I think the consumer has gotten quite comfortable. We were at 5.65% for Q1, which was a few basis points lower than Q4.

Thank you. And then kind of switching over to the construction cycle. I know that you mentioned that there are still some pain points in the back end. I was wondering if you could dig into that a little bit and touch on if there are any construction costs that you're seeing maybe they're a little bit more resilient or if you're seeing any declines?

Yes. No problem, Elizabeth. Good question. We've definitely, this quarter seen some stabilization in our costs. As we've talked about the last several quarters, lumber is finally starting to come through the P&L in the first quarter and then throughout the remainder of this year. Our costs, like I said, probably down just slightly on a square foot basis. Probably the pressure points we've seen more recently are on the concrete side, especially where we see large commercial volumes in our markets. Concrete has gone up a bit. More specifically, in going back to Florida with the hurricanes, our teams in Florida are facing insurance requirements, and they need to pay some premiums to get drywall completed in several of their jobs. But otherwise, I'd say pretty stable and we've seen some small opportunities on the front end, but with the ramp-up and starts again, probably not as optimistic as we had been when the starts have been lower for a while.

I’m going to jump back in here, Elizabeth, because I neglected to mention our to-be-built data point. One of the programs that we introduced early this year is our buy-lock six-year, which is a 12-month lock for our customers that are doing to-be-built homes, and that has continued to gain overall demand. I think it's just giving folks confidence that they can lock in by today and know what the rate is going to be 12 months from now.

Our next question comes from Jay McCanless from Wedbush. Jay, your line is now open. Please go ahead.

Hi, good morning, everyone. One of your competitors mentioned yesterday that their backlogs are comfortable with the current rate environment. Based on your responses, it seems like your backlogs are in a similar situation. Could you provide any insights on this and how much more discounting you might need to encourage customers to move forward?

No, I would agree with that completely. We're seeing that the consumer really is getting very comfortable in that 5.5% range. I think we have some very strategic low 5% or 4.99% money that we very rarely use. But I would say generally, the customer is locking somewhere between 5.25% and 5.75%. In many of our forward commitments and buy-down programs, if rates continue to drop they will have the opportunity for a one-time slowdown. But we are not hearing. It’s kind of like a double win, Jay, because we're not hearing that people need to get back into the 4% or 3.99% and our cost is a lot less than we're not having to buy down as far. I think the consumer has really adjusted to today's environment.

That's great. Thank you. And then the other question I had, I think you said during the prepared comments that roughly 50% of the current land lots that you have were bought pre-2020. Just wondering, when you think that ratio starts to shift and what type of impact it might have on the gross margin as that shift occurs?

Yes. Hey, Jay. It’s Erik. We've been mentioning this statistic for several quarters, and it decreases by about 5% each quarter. This trend will continue, reflecting the percentage of land deals we negotiated in 2020 or earlier. It indicates strong margins ahead, and we are now negotiating at current market rates for margins that align with our understanding of a normalized market. We are pursuing deals that we find appealing at the current market conditions.

Yes, it's very hard to give you forward guidance on what happens two, three years from now as that land continues to evolve.

Got it. And then just sticking on land for a minute. What have land prices done? Have you seen any opportunities to rebid some deals or the sellers holding fast on where pricing is now?

Yes. I think, Jay, fourth quarter and maybe even just into the very first part of the year, I think there was a little bit of a stall in the land market, and that did create a little bit of capitulation mostly in terms of timelines, rather than creating reductions on land prices. I would say that, given our prudence and patience, we were able to get some strategically attractive deals. But there certainly has not been a tidal wave of those coming through. As we sit here today, I think consistent with some of the things you're hearing from us, confidence is kind of gaining. As I suggested, I do think you'll see stabilization in the land market; it certainly didn't fall a lot, but it did hesitate a bit with a lot of land; sellers and buyers are looking at each other not figuring a way through, but I think you're going to start seeing some more activity.

Our next question comes from Mike Dahl from RBC Capital Markets. Mike, your line is now open. Please go ahead.

Hi, this is Ryan Frank on for Mike Dahl. Thanks for squeezing me in here. I wanted to follow up on the spec and BTO commentary. It sounds like near-term, the 60-40 is kind of the right run rate. But as we kind of look out, I mean is that a more normalized area for Taylor Morrison to operate in? Or do you think it will over time drift back down being maybe more BTO heavy given the margin front?

We will continue to monitor the situation based on demand. There is an opportunity to pursue both strategies depending on that demand. Recently, we have seen higher levels in the spec segment, which we appreciate because it provides a balance to our closing cadence and supports our returns. We'll assess the demand as it develops; we also value build-to-orders for the premium margins they offer. Right now, we have a good balance, and we'll observe how the market evolves.

Looking at the past few years, excluding that brief period, the market has been somewhat different. We generally operated within a range of 60-40, sometimes favoring to-be-built homes or specs. As Lou mentioned, we need to stay attentive to the market, which will largely be influenced by the types of communities we have. If we introduce more communities aimed at first-time buyers, we anticipate a higher percentage of spec homes.

Got it. Thank you. And then last one, I think 12%, 13% of your sales at this point come from your digital reservations. Can you just talk about the margin profile difference there? Is it higher gross margin because of BTO? Or is it SG&A savings from lower commissions?

Well, they're actually a combination. So you're right. The 13% depends on how we look at it. 13% is the absolute, where they completed the entire process and they put a deposit online to secure the lot. If we look at, they got all the way through, but they didn't put the money down, and then they called into the roster and wanted to contract, that would be closer to 18%, but that's a combination of our inventory reservations as well as our built to order reservations. We have our built-to-order program in probably 30% to 40% of our communities across the country. So that’s continuing to build. It’s our highest conversion depending on which parts of the country those reservations come from, which depends on the improvement we're seeing in broker participation, with our highest reservations being in Houston, Austin, and Orlando. Home growth tends to be pretty high in Texas, so we haven't seen the same kind of benefit we will when I think we're distributed across the country. What we are seeing improvement on is days to contract from when they start the process to when they complete. Interestingly, the last data point I gave you is this: when we started these programs, participation was mainly around millennials leaving them. Now we're seeing a good balance across all consumer groups: about 40% millennials, 30% Gen Xers, 20% boomers. This is going to continue to fare well for us.

We currently have no further questions. I would like to turn the call back to Sheryl for closing remarks. Please go ahead.

Well, thank you all for joining us to share our Q1 results. We look forward to talking to you next quarter. Take care. Be safe.

Ladies and gentlemen, this concludes today's call. You may now disconnect your lines. Thank you.