Earnings Call
Toll Brothers, Inc. (TOL)
Earnings Call Transcript - TOL Q1 2023
Operator, Operator
Good morning, and welcome to the Toll Brothers First Quarter Earnings Conference Call. Please note, this event is being recorded. I'd now like to turn the conference over to Douglas Yearley, CEO. Please go ahead.
Douglas Yearley, CEO
Thank you, Keith. Good morning. Welcome, and thank you all for joining us. Before I begin, I ask you to read our statement on forward-looking information in our earnings release from last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, interest rates, the availability of labor and materials, inflation, and many other factors beyond our control that could significantly affect future results. With me today are Marty Connor, Chief Financial Officer; Rob Parahus, President and Chief Operating Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer. I'm very pleased with the strong first quarter results. We exceeded the midpoint of our guidance on all key metrics, and we have seen a meaningful uptick in demand that started in January and has continued through this past weekend. In our first quarter, we delivered 1,826 homes and generated homebuilding revenue of $1.75 billion, up 3.7% in dollars compared to the first quarter of fiscal 2022. Our adjusted gross margin was 27.5%, or 50 basis points better than guidance and 190 basis points better than last year's first quarter. SG&A expense at 12.1% of homebuilding revenues was significantly better than both last year’s first quarter and our guidance, as we are benefiting from cost-saving initiatives that we've implemented over the past year. Moving forward, we will continue to execute on additional cost-saving plans to further reduce SG&A expense. Pretax income was $253.8 million, and earnings per share was $1.70 diluted, up 26% and 37%, respectively, compared to last year's first quarter. At first quarter end, our backlog stood at $8.6 billion and 7,733 homes. Although we've seen orders decline by 50% to 60% on a unit basis over the past 3 quarters, backlog is down only 21% in dollars compared to 1 year ago. As a result, we continue to expect solid results this year, and we are reaffirming our full fiscal year 2023 guidance of an adjusted gross margin of 27% and between $8 to $9 of diluted earnings per share. Turning to the sales environment, we are encouraged by what we have seen across our footprint over the past 1.5 months. Beginning in the first week of January, demand has picked up beyond the normal seasonality that we typically see at the start of the spring selling season and has continued into February. We've seen demand improve in most markets across the country, including Florida, Atlanta, South Carolina, Charlotte, D.C. Metro, Pennsylvania, New Jersey, Texas, Colorado, and Southern California. Over the past few weeks, we have also seen signs that demand is improving in markets that struggled the most in the second half of 2022, such as Boise, Phoenix, Reno, Las Vegas, and Austin. We attribute the increase in demand to improved buyer sentiment as inflation appears to be receding and the overall economic outlook seems to be more stable than it was a few months ago. Over the past decade, the housing market has been driven by 75 million millennials entering their prime homebuying years, baby boomers who have been buying homes as they retire and adopt new lifestyles, and migration trends that have favored the Sunshine and Mountain states. At the same time, the U.S. has chronically underproduced new homes. Study after study has shown that home starts have not kept up with household formations for many years. As a result, there now exists a deficit of anywhere between 3 million and 6 million homes in this country. This supply surge was obvious during the pandemic when buyer urgency surged, demand spiked, and prices rapidly increased. It was less obvious in the second half of 2022 when the impact of the sharp and rapid increase in mortgage rates caused many prospective buyers to put their searches on pause. Now, however, with the traditional spring selling season upon us and consumer confidence improving, buyers are coming off the sidelines. The most telling sign that these fundamentals are real and meaningful is the fact that rates didn't have to go back to 3.5% or even 5.5% for buyers to come back out. In fact, this past week, we had the most deposits we have seen in a month, even though rates had moved back up over 6.5%. The improvement in demand is playing well into the strategy we outlined on our December call. In the second half of fiscal '22, with demand inelastic in many markets, buyers were not all that moved by price concessions. With extended delivery times and elevated building costs, we chose not to chase the market down. Instead, we focused on delivering our large high-margin backlog while taking a more patient and balanced approach to new sales and waiting for what we believed would be a better spring selling season. We are now replenishing our supply of spec homes and increasing community count into the spring selling season, taking advantage of improving supply chains and cycle times and building costs that are stabilizing, all while demand appears to be rebounding. As we execute on this strategy, we continue to make appropriate adjustments to product price and incentives at each of our communities based on a detailed assessment of local market dynamics, including elasticity of demand, the size of each community's backlog, and the depth and quality of our landholdings in the market. In our first quarter, about two-thirds of the $117,000 sequential decline in the average sales price of new contracts was attributable to mix. The remaining one-third was due to increased incentives, leading to a first quarter average incentive of about 8%. Today's incentive on the next home sold is about 6.5%. Historically, our average incentive has been approximately 3% over the past 15 years. Based on the recent strength in the market, we expect to continue to pull back on incentives in select communities. With the retail market type and buyers eager to lock in their mortgage and contract, and move more quickly into their new homes, demand for spec homes has been very strong. For the past several quarters, approximately half of our orders were for specs, which we have sold at various stages of construction. Please remember that we define a spec as any unsold home with at least a foundation in the ground. Considering current market conditions, we are strategically starting more spec homes in select markets, but most will be sold early enough in the construction cycle so the buyer will still have the opportunity to personalize their finishes, which is very important to our luxury buyers. We are also pleased that our cancellations have remained low. Cancellations in the first quarter totaled 244, down from the 312 cancellations we recorded in the fourth quarter. As a percentage of backlog, cancellations were 3% versus our long-term average of approximately 2.3%. Our low cancellation rates speak to the financial strength of our buyers, the sizable deposits they make, and how emotionally invested they become as they personalize their new Toll homes. While we are encouraged that buyers are returning to the market, we recognize that the direction of the overall economy, mortgage rates, and the housing market remains unclear. In light of this uncertainty, we plan to remain prudent as we invest in the growth of our business through disciplined and capital-efficient land buying. We have sufficient land in our existing portfolio to support community count growth in both fiscal '23 and 2024, which allows us to be highly selective as we assess new land opportunities and takedowns under existing options. At the end of our first quarter, we owned or controlled approximately 71,300 lots versus 76,000 lots at the end of our 2022 fourth quarter and 86,500 lots 1 year ago. Fifty-two percent of our 2023 first-quarter end lots were owned, and 48% were controlled through options. Excluding the loss of backlog, 54% of our total lots were controlled through options. We continue to expect to generate substantial cash flow in 2023, and we have ample liquidity under our credit facilities. We intend to use excess cash to further reduce leverage and return capital to our shareholders. With that, I will turn it over to Marty.
Martin Connor, CFO
Thanks, Doug. We are satisfied with our first quarter results. Both our revenue and net income grew, and we operated more efficiently than last year. Our net income for the first quarter was $191.5 million, or $1.70 per diluted share, which is a 26% and 37% increase, respectively, compared to $151.9 million and $1.24 per diluted share from the previous year. These numbers set new records for the first quarter. We delivered 1,826 homes, generating homebuilding revenues of $1.75 billion. The average price of homes delivered in the quarter was $958,000. We signed 1,461 net agreements during the quarter, which is a 50% decrease from the first quarter of fiscal year 2022. However, we saw demand improve each month as the quarter progressed, with January's net agreements exceeding the combined total of November and December. February has continued to show strength through the past weekend. The average price of contracts signed in the quarter was around $995,000, down approximately 3% year-over-year and 11% sequentially. A significant portion of this decline was simply a result of the mix of homes sold. Our adjusted gross margin for the first quarter was 27.5%, an increase of 190 basis points compared to 25.6% in the same quarter last year. Gross margin surpassed our guidance due to effective cost control and fewer incentives than anticipated in our deliveries. Write-offs related to home sales gross margin totaled $8 million this quarter, of which about $3 million was due to walkaway costs on 4,100 option lots we chose not to purchase, while the rest was associated with one operating community in Washington. The percentage of SG&A relative to revenue was 12.1% in the first quarter, down from 13.4% a year earlier. It’s important to note that our SG&A expense in the first quarter includes accelerated stock compensation, which was $12 million this quarter compared to $10 million last year. This is an annual expense that impacts only the first quarter. The reduction in SG&A margin of 130 basis points year-over-year reflects the benefits of revenue leverage and tighter cost controls. Overall, SG&A expenses dropped by $15 million in the quarter compared to Q1 of 2022. Due to improved operational efficiency, we are now projecting a decrease in our SG&A expense as a percentage of homebuilding revenue for the full year by 30 basis points, expecting the full year 2023 SG&A margin to be 11%. Joint venture, land sales, and other income for the first quarter amounted to $16.8 million, down from $29.9 million in Q1 of fiscal year 2022. We exceeded our guidance by about $7 million despite a $13 million impairment to reduce the value of land we plan to sell. At the end of the first quarter, we had $2.6 billion in liquidity, which includes approximately $790 million in cash and $1.8 billion available under our revolving bank credit facility. Recently, we extended our $1.905 billion revolving credit facility with 22 banks for an additional five years until February 2028. We also extended the maturity of $487.5 million of our $650 million term loan to February 2018. The remaining $162.5 million of the term loan will partially mature in November 2025 and November 2026. Notably, we have hedged $400 million of our $650 million term loan through interest rate swaps fixed at about 1.5% until November 2025. Our net debt-to-capital ratio decreased to 27.5% at the end of the first quarter, down from 31.9% a year ago. We plan to further reduce our debt by repaying $400 million of senior notes due in April 2023. After this payment, we will not have any significant maturities of long-term debt until fiscal 2026. Our book value per share at the end of the quarter was $55.98, and I want to highlight that we have very few intangibles on our balance sheet. In the first quarter of fiscal 2023, we returned $32 million to shareholders through share buybacks and dividends. We aim for $400 million in annual share repurchases and continue to pay a quarterly dividend of $0.20 per share. Our community count at the end of the quarter was 328, compared to our guidance of 340. The difference from our forecast was primarily due to the quicker-than-expected sales of 11 communities. Our openings generally aligned with our plan. Our forward guidance comes with the usual uncertainties regarding future information. Nevertheless, the 7,733 homes in backlog at the end of the first quarter provide us with good visibility for the remainder of the year. We anticipate approximately 2,050 to 2,150 home deliveries in the fiscal 2023 second quarter, with an average delivered price between $980,000 and $1 million. For the fiscal year 2023, we are maintaining our guidance and project deliveries between 8,000 and 9,000 homes at an average price between $965,000 and $985,000. We expect our adjusted gross margin for the second quarter and the full year to be around 27%. Interest and cost of sales are projected to be approximately 1.5% for both the second quarter and the year. This reflects a 20-basis point reduction in these costs year-over-year as our leverage decreases. We estimate second quarter SG&A as a percentage of home sales revenues to be about 11.2%, and for the full year, we now expect it to be 11.0%. Other income, income from one unconsolidated entity, and land sales gross profit is anticipated to be approximately breakeven in the second quarter and $125 million for the full year. Much of this anticipated other income for the year is expected to result from sales of our interests in certain established apartment communities created by Toll Brothers Apartment Living in partnership with various collaborators. Despite the unpredictable market for these established rental properties due to capital market fluctuations, our occupancy rates remain strong, and we currently expect to sell our interest in four of these joint ventures by the fiscal year's end. We are projecting a second quarter tax rate of about 26% and a full year tax rate of 25.7%. Our weighted average share count for the second quarter is expected to be around 112 million shares and 111 million shares for the entire fiscal year 2023. This is based on a targeted repurchase of $100 million in common stock during the second quarter and $400 million for the year. Overall, this results in an estimate of between $8 and $9 per share for the full year, which would raise our book value above $60 by the end of fiscal year 2023. Lastly, as Doug pointed out, we expect to keep generating strong cash flow in 2023, remaining cautious about new land purchases. However, we believe that based on the land we currently own or control, our community count will grow by 10% by the end of fiscal year 2023 from the initial count of 348 communities. We also have enough land to increase community count in fiscal year 2024. Now let me return it to Doug.
Douglas Yearley, CEO
Thank you, Marty. Earlier this month, Fortune Magazine named us the #1 World's Most Admired Homebuilding Company. This is the eighth time we have received this honor. I would like to thank all of our Toll Brothers team members for achieving this tremendous recognition. They continue to demonstrate their dedication to our brand and to our customers, and for that, I'm very grateful. I'm so proud of our team and of our company. With that, Keith, let's open it up to questions.
Operator, Operator
And the first question comes from Stephen Kim with Evercore ISI.
Stephen Kim, Analyst
Thanks for all the great color here. Obviously, it seems like the tone of your demand has stayed strong. So I'm not going to ask about that; probably others will, but it's very encouraging. I was curious about your customer acquisition costs. This environment we've been living through over the last couple of years has been so unusual. But as you look forward with a market that potentially is normalizing, can you give us a sense for what your customer acquisition costs look like relative to, let's say, what it was like pre-pandemic? I'm thinking things like external broker fees and maybe increased use of the Internet to attract incremental customers to give us a sense for where your SG&A margin is likely to trend over the next couple of years?
Douglas Yearley, CEO
Sure, that's a great question, Stephen. The money we spend is digital today; we don't advertise on TV, radio, or in the Sunday paper, and it has become more efficient as we've improved our targeting of clients through digital means. We're very proud of our website, which is managed by our internal web team, and we receive a lot of positive feedback from clients about their ability to navigate our site to find the homes they want. I believe we will continue to increase our efficiency in digital marketing spending, which is very important to us. The largest expense remains brokers and realtors, but we are pleased to see engagement with clients decreasing. About five to ten years ago, around 60% of our sales involved a realtor, and that figure is now approximately 40%. A year ago, with our allocation process, many clients were coming in without a realtor as they were waiting for their turn. However, in today’s market, having this number down to 40% is encouraging. Clients are moving more quickly or exclusively to new homes, leveraging our website to gather all necessary information and feel confident buying without a broker. The community is important to us, and we rely on it, but it is a significant expense that has decreased. We will need to observe this trend over the next few quarters to determine if it represents a lasting change in the business. For now, we are encouraged that this figure has remained around 40% during a time we did not expect it to drop. As a result, we anticipate becoming more efficient in SG&A.
Stephen Kim, Analyst
Got you. That's helpful. I wanted to ask about the difference you're observing between your affordable luxury customers and your more traditional luxury customers. Regarding your comments on incentives, you mentioned that they are currently running at 6.5%, down from 8% in the previous quarter, which suggests an improvement. I would like to understand whether this reduction in incentives is mainly due to lower costs associated with the mortgage rate buydown resulting from a decrease in the prevailing market rate, or if it's a result of proactive measures taken on your part to avoid offering substantial incentives. Additionally, is there a difference in the incentive trends between the affordable luxury segment and the traditional luxury segment?
Douglas Yearley, CEO
Sure. So let's start with sales. The sales cadence between affordable luxury, luxury, and what we call empty nester active adult, which is targeted for the first quarter, was the same. We were down 50%, as we mentioned, and each of those segments was virtually identical. So they're all performing about the same. When it comes to the incentives, it is slightly higher on the age restricted than it is on the affordable luxury, and it is quite significantly lower on the true luxury, our bread and butter. So let's just pick a number of 8% to go back to the first quarter. Age-targeted, age-restricted ran about 8.5%, affordable luxury ran about 8%, and the luxury ran around 4-ish percent in that range. The luxury client is wealthier. They're less impacted by rate; it’s just a different buyer as we've talked about for many, many years. We think we've had that advantage in a volatile rate market. With respect to what we're doing with incentives, the increase in demand in January and now into February, when we look back on it, it was partially driven by us increasing some incentives, as I mentioned in the prepared comments, as we saw demand become more elastic; we could incentivize a little more and see good results. But we think it is more driven by buyer sentiment, the seasonality, and people coming back out. They absorbed the higher rate, and they wanted to buy. When they went out to the market, they realized the resale market is so tight. There's no opportunity, and they came to us, and they started hearing our salespeople talk about significant increases in traffic, and the boss saying I may be raising prices or dropping incentives, and there became this sense of urgency with the client that, oh boy, it sure sounds like we're off the bottom. I don't want to miss this opportunity. Even though, yes, the rate is higher, it sounds like Toll Brothers might be raising some prices or dropping some incentives. And that urgency was created, and it's real. We are dropping incentives. We are raising prices. We're doing it selectively. We're doing it surgically, but it's happening throughout the country, which is one of the reasons why I explained in my prepared comments that today's incentive is less than it was back in December, and we think that's going to continue to go down. So that’s the market environment. That’s the breakdown between our product mix. I hope I helped you.
Operator, Operator
And the next question comes from Michael Rehaut with JPMorgan.
Michael Rehaut, Analyst
I know there's a lot of discussion. You just kind of alluded to some things around buyer confidence versus interest rates. It's obviously very interesting that you're saying the strongest sales weekend has been this past, and that obviously, after a pretty tumultuous February so far. I guess the question is, obviously, sometimes it takes a little bit of time for a move in rates to have its impact into the marketplace. The NBA purchase app index was down pretty sharply this morning. So just wanted to get your take, as you've seen the volatility in rates over the past 6 months, how you view this most recent move, and obviously, it's a pretty encouraging data point over this past weekend. But how do you put into context this most recent move over the past month? And does it kind of create any concerns or anything in terms of traffic over the last few weeks that might make you concerned as you saw a lot of volatility, obviously, over the last two or three quarters?
Douglas Yearley, CEO
Sure. So Mike, if you had asked me if the rate goes from 7.38 to 6.25, these buyers would be coming back, I would have honestly said no, thinking it wasn't enough. But they did come back. And then when you asked me about the impact of REITs moving from 6.25 to 6.75 over two weeks, I would have expressed concern. It's true that I'm worried, and yes, it's just one week. We've had rates go up for two weeks now, and the last week has been better. The week before was the Super Bowl week, which typically isn't as strong compared to the week after, which is the current scenario. So it’s still early to get too excited, but it is very encouraging that buyers returned at 6.25. It didn't require a drop to 5.5 or 4.99, nor did it need the lower rates we saw a year ago at 3. That was really promising, and even more so with the recent data showing that as rates move from 6.25 to 6.75, buyer activity remains strong. Traffic is good. Web activity is robust. We've created urgency in the sales center by reducing incentives and increasing prices, and buyers are responding. However, I won’t claim we're out of trouble. We're aware of the rate volatility and the ongoing economic uncertainties. Things are looking better—inflation is decreasing, the Fed appears to be managing effectively, and stock markets have been strong recently. Our buyers are less influenced by these rates for various reasons we've discussed previously. That's encouraging given the current plus rate environment. Keep in mind that the spread from the 10-year to the 30-year is 300 points, while historically it tends to be in the high 100s. If this spread tightens back to historical levels, we’ll be in a favorable position. Buyers aren't fixed on being locked into a 6.5 rate for 30 years. Refinancing is a common practice. Our buyers are knowledgeable, most have owned homes before, and nearly all have refinanced at some point in their lives. For a $2,000, $3,000, or $4,000 difference, they can move from a higher rate to a lower one. Additionally, they want to resume their lives. After taking eight months off, they’re seeing urgency and returning. While rates are important and affect affordability, they are not the primary factor for our business model.
Michael Rehaut, Analyst
I appreciate those comments, Doug. A lot of it makes sense, especially regarding refinancing. I also wanted to confirm something from the previous question about the decline in average incentives from 8 to 6.5. Did I understand correctly that this decline is due to actual reductions in incentives or because the cost of mortgage rate buydowns has become less expensive?
Douglas Yearley, CEO
It's incentives. It's not a difference in buydown rate.
Michael Rehaut, Analyst
Okay. Well, the heart of the question, though, was looking at the guidance. You took down SG&A due to some progress on cost saves. The gross margin, though, I'm curious if that was more based on the 8% average incentive and if you continue to have 6.5% or potentially even lower, could that ultimately drive some upside in your gross margin guidance for the full year? I think you said that the upside in the first quarter was due to less incentives as well.
Martin Connor, CFO
Yes, Mike, it's Marty. Thanks for your questions. We expect our gross margin to be relatively consistent through the balance of the year to get to that 27% for the year. There are estimates in that, obviously, with respect to what's in the backlog and what may be sold and settled in the interim. But we feel like we've accounted for the puts and takes that we showed in the guidance we've given you.
Douglas Yearley, CEO
And part of that, Mike, there is a budget in place as part of that guidance for that occasional need to work with some of the backlog to get them to close. But we've been very pleased with how low that can rate is and how little we have had to spend with that backlog.
Operator, Operator
And the next question comes from Rafe Jadrosich from Bank of America.
Rafe Jadrosich, Analyst
It's Rafe. Just first, the net debt to cap is already kind of at the low end of your historical range. Can you just talk about the right level you're thinking about going forward? And then with the market improving a little bit here and supply chain improvement, you're going to generate a lot of cash. Just how do you think about land spend versus buybacks going forward?
Martin Connor, CFO
Regarding the net debt to capitalization, we are comfortable with the gross level being in the high 20s and the net level in the mid-20s, which aligns with our conversations with the rating agencies. These figures may vary slightly based on timing and debt maturities. When it comes to new land acquisitions, debt repayments, and stock buybacks as part of our capital allocation, it is a careful balance. We are fortunate to have the financial flexibility to pursue a combination of these strategies. Currently, land deals must meet a much higher underwriting standard, and there has been a slight decrease in them. However, we have a significant number of deals in our pipeline that conform to these standards, particularly those that were underwritten several years ago, and we are actively moving forward with those. Additionally, we plan to repay $400 million of debt in the second quarter while continuing to acquire land and repurchase our shares.
Douglas Yearley, CEO
And I would point out that over the last five quarters, we have walked away from 14,000 option lots. Part of our strategy a few years ago to get more capital-efficient and have less risk in our landholdings was to option more land. As you've seen by the modest walkaway costs that we've had over those five quarters, it's been pretty painless to walk away from those lots because in today's environment, they weren't working. Now that will be replenished at the right price and also with capital-efficient strategies. But I think it shows it's the payoff of being very capital-efficient and selective in how we've been buying land that we can walk away from that number of options painlessly.
Rafe Jadrosich, Analyst
That's helpful. And then in the gross margin guidance, can you talk about sort of the underlying assumptions or just what you're seeing in terms of construction costs going forward here? For example, can you talk about maybe for how it started today what the construction cost that you would anticipate versus a similar house 3 months ago? Like, have you started to see that come down? And what type can we expect from a margin perspective there?
Douglas Yearley, CEO
Sure. So let's start. Supply chain is improving. Cycle time is improving as contractors have more capacity. And costs have stabilized, except for lumber, which is our biggest material cost, and it has come down significantly. There’s a very nice tailwind with lumber. It's flattened out in the last month or so, 6 weeks maybe. But before that, it was coming down pretty rapidly every week. We do believe, as the year progresses, that there will be other costs, both labor and materials that will be coming down. But right now, costs are stabilized, except for lumber, which is a nice tailwind. So stay tuned for the balance of the year. We are actively talking to trades; the normal conversation is the trade that didn't have capacity now comes and says, 'Hey, I've got an extra framing crew or two that could use some work.' That is the opening to get a price concession. And so that is the beginning of the process of seeing costs come down.
Operator, Operator
And the next question comes from John Lovallo with UBS.
John Lovallo, Analyst
The first one is on just going back to SG&A, down $15 million year-over-year on a similar revenue base. I know you talked about broker commissions and a few other things done. But what are some of the more structural cost-saving plans that you guys have been successful with?
Douglas Yearley, CEO
Headcount. We're trimming the firm. We're learning how to be more efficient with fewer people. As we have retirements, we're replacing from within, we're promoting from within, without needing another person. We've gone through a very difficult, thoughtful round of cuts in the last 30 days. We have a plan to become even more efficient with headcount and some other initiatives in the firm, but it's primarily headcount.
John Lovallo, Analyst
Got it. Maybe if I could just follow up on that. Is there a risk that you're going to negatively impact growth if things were to pick up here given those headcount reductions?
Douglas Yearley, CEO
No.
John Lovallo, Analyst
Okay. Okay. Great. And then second question is just digging into buyer mentality and psych here, which is pretty interesting. I mean, it looks like there was a slight step-up in cash buyers quarter-over-quarter, at least as a percentage. You mentioned some fear of missing out, maybe more confidence. But in general, from what you're hearing, do you think folks are just getting more accustomed to higher interest rates?
Douglas Yearley, CEO
Yes, cash buyers increased from 20% to 23%, which we anticipated. It's logical; when interest rates rise, those who can afford to make cash payments will do so. However, we believed it would take some time for buyers to adapt to the higher rates, and that's exactly what occurred. This situation mirrored what we experienced from the mid-90s to the mid-2000s, during a period with mortgage rates exceeding 6%. It's been quite a while since we've faced such rates, and there was indeed an adjustment period. Our fundamentals remain strong, supported by migration trends, demographic shifts among millennials and boomers, pent-up demand, and a tight resale market with a deficit of 3 to 6 million homes in the country. This significant demand-supply imbalance has persisted for a decade and cannot be overlooked. As buyers paused to adjust to the increased rates, it seems they are now starting to return, as we've observed over the past seven weeks.
Operator, Operator
And the next question comes from Susan Maklari with Goldman Sachs.
Susan Maklari, Analyst
My first question is around the commentary that you gave about increasing your spec construction just given that you're looking for quick move-in homes. Can you give a bit more detail on the number of specs you have and how you're thinking about adding supply as we go further into the spring?
Douglas Yearley, CEO
Sure. We currently have around 2,200 specs. We define a spec as being at the foundation stage or beyond. We sell many of these with enough time for clients to choose finishes, including kitchen cabinets, countertops, flooring, and other features showcased in our design studios. Our business model targets about 30% to 35% spec homes, meaning we will be starting more homes without a buyer, which allows us to keep them in the market. This approach is influenced by market and community dynamics, but it is our current target. I'm confident about the 2,200 specs we have, well distributed across different stages from permit to foundation, framing, finishes, and completion. When a client wants a house in 60 days, we likely have it ready. If they prefer to wait for 4 months to customize some finishes, we can accommodate that as well. We have a good spread in our inventory. Our plan is to continue starting new specs to replenish our supply as we sell our current inventory, and we expect to achieve that 30% target this year.
Martin Connor, CFO
Susan, it's a carefully managed process to determine how many specifications to begin based on recent sales and the construction stage of other units. We've developed sophisticated methods for evaluating this by market, community, construction stage, and sales pace.
Susan Maklari, Analyst
And given the guide and the commentary, is it fair to assume that the margin that you're realizing on those specs is not materially different than what you're getting on the core product?
Douglas Yearley, CEO
Through COVID, specs generated a higher margin because people were paying a premium to get into a home quickly. From the summer through the end of the year, specs were getting a lower margin than to-be-built because the market was a lot softer as buyers were on the sideline. Now we are trimming the incentives on specs faster than the to-be-built. So that's a long answer to say, yes, today, the margin between spec and to-be-built has narrowed. We think if this demand for specs continues, we're going to get back to having the spec margin be a bit higher, but we're not there yet, but it is beginning to trend in that direction.
Operator, Operator
And the next question comes from Truman Patterson of Wolfe Research.
Truman Patterson, Analyst
First, I'm just hoping to get perhaps a clean number on orders pricing because a couple of quarters ago, you think there was an accounting and mix issue in the order ASP. I understand that incentives have reduced recently, but sometimes incentives can turn into base price cuts, et cetera. So I'm trying to understand what core pricing might be down from peak between base price cuts and just all-in incentives?
Martin Connor, CFO
Well, we tried to address that in our comment that one-third of the price difference this quarter versus last quarter was associated with incentives. So call that $35,000 to $40,000.
Douglas Yearley, CEO
Which is also base price drops. It's all one bucket.
Truman Patterson, Analyst
Okay. Got it. Okay. So that's kind of an all-in number that you all gave. Perfect. And then over the past decade or so, you all have had some pretty nice geographical expansion from mid-Atlantic, Northeast, out west and south, et cetera. I'm trying to understand, given the softness in the market, the recession that we've just gone through, are there any areas that you might find some land opportunities or geographical areas that you're targeting to expand to in the coming years?
Douglas Yearley, CEO
We have made significant expansions in the last three to four years, entering markets such as San Antonio, Tampa, Portland, Salt Lake City, Spokane, and Colleen. Recently, we opened a location in Long Island. Currently, there isn't a particular new market we are focusing on enough to share details about. However, we continue to look for opportunities. Our primary focus is on growing and diversifying within our existing core markets where we are performing well. This approach will aid in leveraging our sales, general, and administrative expenses since smaller market entries can be inefficient for several years until they become established. In the next couple of years, you can expect less expansion into secondary and tertiary markets and more growth in our core areas.
Fred Cooper, Senior VP of Finance and Investor Relations
The one market you didn't mention is Nashville where we do have expense and we don't have any communities to open yet.
Operator, Operator
And the next question comes from Mike Dahl with RBC Capital Markets.
Mike Dahl, Analyst
Just a follow-up on the orders environment. It was helpful in terms of the color on January being greater than November and December combined. So I guess high-level math would be January had to be at least around 750 orders compared to 350, give or take in November and December, but could you put a finer point on just help walk us through the monthly trends? And then when you talk about the February improvement, if you can give us some sense of quantification on orders, not just deposits.
Douglas Yearley, CEO
All right. I got it right here. So November was down 72% year-over-year. December was down 55% year-over-year. January was down 31% year-over-year. January sales were the highest pre-January 2020 since January of 2005, and February is the same as January.
Mike Dahl, Analyst
Okay. That's very helpful. Fred, when you say the same in unit terms or a percent change?
Fred Cooper, Senior VP of Finance and Investor Relations
Units.
Douglas Yearley, CEO
Yes.
Mike Dahl, Analyst
My follow-up question is regarding the land side. You have significantly tightened your underwriting. You’ve provided some high-level metrics about combined margin and IRR thresholds in the past. Where do those stand now? Have you maintained the same thresholds, or have you adjusted them based on current observations?
Douglas Yearley, CEO
We've maintained our approach. Previously, we targeted a 55% combined gross margin IRR for land acquisitions. That increased to 60% and is now at 65%. If we're aiming for a 25% gross margin, we require a 40% IRR. For a 30% gross margin, we need to achieve a 35% IRR. It's a challenging environment to secure deals. We do have some deal flow, but we are currently being very disciplined regarding our stringent underwriting criteria.
Martin Connor, CFO
And we’re using current paces. In other years, we might have had a 12-month pace put in front of us, and we say that 12 months don’t matter. We need to see what happened over the last 4 weeks, 8 weeks kind of pace because that should, that’s what you should annualize, not the full 12 months.
Douglas Yearley, CEO
Right. Now as cycle times come down, as some building costs come down, the team is allowed to plug in current conditions for that, too, but they have to work off of current market conditions when it comes to sales price and sales pace. So we have some frustrated land teams out there, but that’s good. They’re hubs. And we celebrate deals. We’re doing deals, and we make sure everybody knows that the treasury is open. It’s just tight.
Operator, Operator
And this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing comments.
Douglas Yearley, CEO
Thank you very much. Thanks, everyone, for your interest and support. We appreciate it very much. We’re always here to answer any individual questions you may have. And what is it, 6 PM in Philly today, so spring is coming. Thanks so much. Take care.
Operator, Operator
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.