As last year’s mortgage rate shock threw the U.S. housing market into a sharp slowdown, many homebuyers started to get cold feet, worrying they’d be buying at the peak. Some of those buyers even backed out of their contracts and left their earnest money on the table. That saw the cancellation rate at D.R. Horton, the nation’s largest publicly traded homebuilder, spike from 16% in the first quarter of 2022 to 32% in the third quarter of 2022. It was starting to look like builders might be in for a bumpy ride.
Fast-forward to June 2023, and stocks of homebuilders including D.R. Horton and Lennar have set new all-time highs, as new-home sales continue their speedy resurgence. Consider D.R. Horton, in particular, which saw its cancellation rate fall back down from 32% in Q3 2022 to 18% in Q2 2023.
To understand how builders were able to beat 2023 expectations—which most economists thought would be a bad year for housing—Fortune reached out to D.R. Horton’s CEO, David Auld.
As the market started to sink last year, Auld says, builders began to reduce their profit margins—which had grown to record levels during the boom—to do things that would entice buyers back into the market. For some builders, that meant offering aggressive rate buydowns, which in some cases lower buyers’ mortgage rate below 5%. In some communities, it required cutting prices by 5% and 10%. In fast-correcting markets like Austin, where D.R. Horton is the largest builder, some new-construction communities saw home prices cut by over 15%.
Entering 2023, builders’ affordability adjustments—relative to a lack of adjustments in the resale/existing-home space—combined with a lack of existing-home inventory put single-family builders in a good spot.
For evidence of the rebound—and how they did it—just look at D.R. Horton's earnings.
Back in April, D.R. Horton reported that its Q2 2023 revenues were down 0.3% from Q2 2022. However, its net income (i.e. profit) in Q2 2023 was down 34% from its net income level in Q2 2022. Those numbers suggest that affordability improvements, like mortgage rate buydowns, are eating into D.R. Horton's profits, while also helping to boost sales.
Despite the mortgage rate shock, D.R. Horton was also able to move up from No. 124 on the Fortune 500 list in 2022 to its highest-ever ranking of No. 120 in 2023.
To understand the nuances for how builders cornered the market, Fortune did the following Q&A with D.R. Horton's CEO David Auld. Auld has been at the helm of the Arlington, Texas, based builder since 2014, and has led D.R. Horton through the post–Great Financial Crisis era, the COVID-19 recession, and the 2022 mortgage rate shock.
Below is Fortune's Q&A with Auld.
Fortune: D.R. Horton beat earnings and revenue estimates for the second quarter. What explains the sales improvement this spring? How did D.R. Horton bring buyers back into the market following last year's mortgage‐rate‐induced slowdown?
Despite higher mortgage rates and inflationary pressures, fundamental housing demand has remained solid, and our net sales orders improved during our second fiscal quarter due to normal seasonal factors, coupled with our use of incentives and pricing adjustments to adapt to changing market conditions.
The typical seasonal trend for D.R. Horton is a roughly 50% increase in our net sales orders from the December-to-March quarter. This year we experienced better than normal seasonality, with a 73% sequential increase in our net sales orders, primarily the result of the existing and growing imbalance of demand versus supply.
To address affordability concerns in the market, we introduced increased incentives into the market and adjusted base pricing of our homes where necessary. Our most successful incentive recently has been interest rate buydowns. We are generally offering a point below market on a 30‐year fixed rate mortgage for the life of the loan.
You told investors this spring that “pricing adjustments” helped D.R. Horton bring demand back into the market. In what types of communities/regional housing markets did D.R. Horton cut house prices over the past year? And roughly how big were those price cuts?
Our average sales price on closings in the second quarter of fiscal 2023 was $378,800, down 6% from a high of $403,700 in our fourth quarter of fiscal 2022. Pricing adjustments are made by our local market operators on a community‐by‐community basis based on market conditions and demand. Price adjustments varied greatly across our operating footprint of 110 markets and 33 states, and generally speaking, pricing held up better in our communities in Florida.
Given the sales improvement, could builders soon pull back on buydowns or incentives?
If the market were to continue to improve, we would expect the opportunity to be able to either pull back on incentives and/or begin to start gradually increasing the base prices of our homes. This will still be done on a community‐by‐community basis based on local market conditions.
During the Pandemic Housing Boom, builders like D.R. Horton expanded their profit margin. Having the breathing room to then reduce those margins to “find the market,” analysts say, has helped builders to weather the mortgage rate shock. Do you agree with that assessment, and how did that play out for D.R. Horton?
We do agree with that assessment. Even with a decline in our gross margins due to the significant increase in rates in the second half of calendar 2022, they are still above our historical norm of 20%. Our home sales gross margin in the March quarter was 21.6%, and we publicly guided to a June quarter gross margin in the range of 21% to 22%. Our homebuilding SG&A [selling, general, and administrative expenses] is still at historically low levels, with our consolidated pretax margin strong in the mid‐teens.
Deutsche Bank recently released a paper saying that the “U.S. housing market was simply navigating a mid‐cycle crisis” last year, and the lack of housing supply would keep builders busy in the years ahead. How does that assessment compare to your personal view? Just how “underbuilt” is the country?
It is hard to pinpoint exactly how underbuilt the country is, but I firmly believe we are still in an extremely undersupplied housing market, for both new and existing homes, likely for years to come due to development and construction capacity constraints in the industry.
According to an analysis conducted by John Burns Research and Consulting, institutional investors—those owning over 1,000 homes—bought 90% fewer homes in January and February than they did in the first two months of 2022. Did you see that manifest in D.R. Horton's build‐for‐rent business?
We still see numerous buyers interested in purchasing our multifamily rental projects and our single‐family rental communities, and we have continued to sell our rental communities to investors at a good pace. As we continue to scale those businesses, D.R. Horton is uniquely positioned to be the largest provider of rental communities to the growing number of institutional investors focused on reducing the cost and increasing efficiency of the acquisition and management of their portfolio.
As of Q2 2023, what percentage of D.R. Horton's business is build-for-rent? And what do you think that figure will be in, say, five years?
As of March 31, 2023, our rental inventories (both multi‐ and single‐family) were $3.3 billion, or approximately 14% of total inventory. We don’t have a set target for the future size of our build‐to‐rent businesses. We plan to continue to consolidate share in the rental market, just as we have steadily aggregated share in the for‐sale side of our business for many years.
