There Are Three Kinds Of Buyer Demand: One Matters The Most

John McManus -

Like a rose, homebuyer demand is demand is demand, right?

Its raw materials – demographics, job and income growth, and household- and family formation – are its common genetic code. And, of course, those upward trajectories of demand's genetic code are constrained so tightly by current and near-future housing supply that their unfailing strength is widely held to be one of the economy's reliable, sure-shot force factors.

Still, we'd suggest right now that demand among would-be homebuyers, demand for new homes, and demand for a particular homebuilder's homes are three separate, discrete, and distinct domains, although commonly conflated as the same.

What this suggestion means on a builder by builder level is this: Although most builders' well-engineered "shock absorber" – hefty gross margins – has undergone moderate stress in the past six or seven months to keep selling pace up, that shock absorber's got its work still cut out for it in the stretch ahead.

The reason for our suggestion for each builder to filter out firm-specific demand recognition from broader assumptions – and make sure to keep double-counting customer demand that could easily cross the street and become some other builders' "demand pool" – comes as an array of contextual forces bode economic and financial turbulence on top of what's already a hard-to-fathom post-Covid era macro backdrop of uncertain duration. They include, and not in any order of priority or impact assessment:

In isolation, each of these in a different broad-based economic environment, might have only a superficial and momentary impact on consumption and structural economic patterns.

Is it fair to consider them in relation to one another to judge how they could impact so-called demand? Is it wise not to?

Each of these factors taken separately might be assumed to contain some level of demand destruction. Perhaps none, nor all, will add up to a sizable impact on late 2023 or 2024 purchasers of new homes. Still, that's what owners and principals and key investors and lenders need to assess as they look around a very noisy corner of the near- and mid-term future at what lies ahead.

In remarks to investment research analysts tied to KB Home's strong Q3 2023 financial and operational results, Jeff Mezger, Chairman, CEO, and president of KB Home, and his C-Suite team provide a text-book case study in the ways homebuilding strategists characterize new-home buying demand, both generally and specifically.

Here are a few verbatim highlights that reference demand in its various forms and impacts. For other operators – big, small, public, private, single-market local, multi-market regional, or multi-regional – there are three key take-aways.

  • Don't assume demand is demand for your new-home offerings, prices, locations, and communities.
  • Assume that your profit margin "shock absorber" will need to continue to fund buyer concessions in the months ahead as the cost-of-living crisis, credit crisis, and broader economic weakening play out, albeit in some local economies more than others.
  • Assume that your operational offsets to costs – cycle-times, renegotiation of building materials and products costs, value-engineering – will need to ratchet up in significant total cost per home savings to maintain margins at a going concern level.

Let's turn now directly to the KB Home C-suite for their words on these matters:

The macro demand-vs.-supply talk-track

Jeff Mezger, Chairman, CEO, and President

With over 140 million combined millennials and Gen Zs, first-time buyers will likely fuel the housing market over the next decade, which is favorable for our business as we primarily serve the first-time and affordable first move-up segments."

The New-Home Windfall Demand Effect

Jeff Mezger

The outlook remains healthy for housing market conditions driven by low existing home inventory and constrained availability of new homes at our price points."

Company-Specific Demand Metrics

Jeff Mezger

Demand for our product at our price points was solid. On a per community basis, our absorption pace averaged 4.3 monthly net orders, higher than our historical pre- pandemic third quarter average. Although interest rates rose as the quarter progressed, our net orders remained fairly consistent month to month. The combination of an acute shortage of homes together with the demographic factors I just referenced, led to strong absorption and a cancellation rate that has returned to historical levels.
... These buyers continue to have strong credit profiles with about 60% of KBHS customers utilizing a conventional mortgage and over 90% using fixed rate products. The average cash downpayment held steady with the second quarter at 15%, equating to roughly $70,000 down. The average household income of our KBHS customers was over $130,000, higher than the median household income in our submarkets and we had an average FICO score of 735."
... In a Built-to-Order business, you're really a consumer laboratory every day, you're getting feedback on what the consumer wants, what they think and most importantly what they buy. We watched the trends closely on frequencies-by-plans in this area. In this community, is it rotating to smaller plans or not? If it is then we haven't seen real evidence of it. Yes, we are down incrementally a few feet on average, but it's not -- it hasn't moved much over the last nine months. If it did, we can quickly go introduce a smaller model into the model park and we'll do so to help sales there. We’d rather do that and hold margin than just drop price on what you're offering and hit the margins. So, it's one of the levers we pull and we've done it a lot in the past, in part because we have product on the shelf, we can go, plug and play. It's already plan checked, it's approved, and we can go insert it as a model and help that community succeed. So it’s one of those things we track very closely."

Real-Time Agility - Margin As Shock-Absorber

Rob McGibney, Executive VP, Chief Operating Officer

Our strategy has remained consistent on optimizing each asset on a community-by-community basis, balancing pace, price, and margin. Demand was healthy across our markets, enabling us to raise prices in 65% of our communities while decreasing prices in only 10%. We offered mortgage concessions as needed, primarily in cases where the buyer did not qualify. Anecdotally, we hear from our teams in the field that buyers are compelled by the combination of the best price and value, not just the best interest rates which is aligned with our business model and our culture of selling Built-to-Order homes."

Operational Improvement

Rob McGibney, Executive VP, Chief Operating Officer

Our divisions executed well on our plans to reduce build times with a 35-day sequential reduction in the 3rd quarter. As a result, we are currently building homes in approximately six months. This progress puts us another step closer to returning to our historical level of between four and five months. Further improvement remains a priority, which we expect to achieve by simplifying and refining our product offerings while leveraging the evenflow production inherent in our Built-to-Order model and the long-term relationships we have developed with our trade partners and suppliers.
Lower build times will help to generate incremental deliveries and drive higher inventory turns and cash flow, in addition to helping our sales effort in personalized homes. We are essentially back to business as usual with our supply chain outside of some specific challenges related to roofing materials and electrical equipment, specifically transformers which has been widely discussed across our industry. We also seeing an improvement in the availability of labor for our trades. We significantly reduced our direct costs by over $20,000 [per home] in the first half of 2023 relative to their peak in August 2022, which helped to offset the price reductions we did earlier in the year to generate sales."

At the end of the day, demand in fact is really the business that you record rather than the business you expect to tap into. That difference will separate those who're able to pass through the array of forces that could impact macro demand, and come out thriving.