Toll Brothers' Choice-At-Scale Spec Pivot Fits A 'Life Happens' Buyer

No pressure, Federal Reserve Chairman Powell.

There’s a saying that economic expansions don’t die of old age: They’re murdered by the Federal Reserve.

Fed Chair Jerome Powell has spent the past two years determined to beat inflation even if it resulted in recession. Now he’s on the brink of winning the battle without bringing down the economy, but the next few months will be crucial." – Nick Timiraos, Wall Street Journal [gift link]

Hanging in the balance on the eve of Powell's intensely-anticipated speech tomorrow from the Federal Reserve's annual Jackson Hole, WY offsite, is a gamut of implications for the new home marketplace in late 2024 into 2025, ranging from math to psychology.

In that limbo – which may or may not expand or shrink after tomorrow's speech and a more and more likely September Fed rate cut, beginning a downward retrace in the cost of borrowed money for both businesses and consumers – one baseline demand group has remained undeterred.

They're more and more widely known as the "life happens" adult households, whose motivations to move out of their current homes and into new homes are dramatically less likely to be deterred by either the math challenges of today's market or its more recent psychological hesitancies.

In such a challenging landscape of U.S. market-rate new-home construction, where volatile economic conditions and fluctuating demand have caused uncertainty, one homebuilder stands out as a master in marketing to the "life happens" segment: Toll Brothers.

Toll Brothers deftly navigates the complexities of today's market by focusing on a buyer group driven by life-stage milestones — those whose financial wherewithal sets them above more price- and interest-rate sensitive buyer prospects, and whose needs are precipitated by events such as marriage, the birth of a child, divorce, career relocations, or the necessity of combining households.

Toll Brothers' particular mastery – as is evident in commentary during the organization's Q3 2024 earnings call this week – is in overcoming that psychological "deferral mindset" even as it pivots to a more fluid production, marketing, and selling system by ramping up its ready-to-own homes.

Strategic Positioning and Financial Performance

Toll Brothers' Q3 2024 earnings report, as discussed by CEO Douglas Yearley and CFO Martin Connor, underscores the company's strategic shift towards a more diverse and adaptable business model, one that fortuitously resonates strongly with a "life happens" buyer segment that likely will serve as a baseline of new-home demand at least through the end of the year, and more likely well into 2025.

In an earnings call overview, Yearley highlights the delivery of 2,814 homes at an average price of $968,000, generating record third-quarter home sale revenues of $2.72 billion, with an impressive adjusted gross margin of 28.8%. This financial strength is a testament to Toll Brothers' ability to efficiently meet the needs of a broad range of buyers, including those in the "life happens" category who are less sensitive to price and more driven by the necessity of life changes.

Despite facing uneven demand across the quarter, with notable fluctuations in May and June, Toll Brothers saw a resurgence in July that carried into August. This resilience in the face of market volatility speaks to their ability to adapt and maintain strong sales momentum, a critical quality when catering to buyers who need to make a move due to life-stage events.

Scaling Choice: Mass Customization

At the heart of Toll Brothers' strategy is its ambitious push to scale "choice" for homebuyers — a concept that encompasses the ability to personalize and customize their homes to reflect their individual dreams and needs.

What Toll Brothers is driving towards, and beginning to achieve, is a strategic shift towards "mass personalization" and mass customization. This is embodied in their evolving 50-50 spec versus built-to-order (BTO) business model, which allows them to offer a highly customizable home buying experience while maintaining efficiency in production and sales.

Our strategy of widening our geographies and price points to include more affordable homes and increasing our supply of spec homes has helped us meet demand while becoming a more efficient homebuilder," Yearley tells analysts during the earnings call this week. "We sell our specs at various stages of construction, which provides many of our buyers the opportunity to personalize their homes at one of our 40 design studios nationwide. This offers our spec buyers a degree of choice, which is a key pillar in the Toll Brothers buying experience, while providing us with a faster and more efficient construction schedule."

Just as homebuilding giants like D.R. Horton and Lennar have embraced a systems-driven business model focused on continuous evenflow production, sales, and closings, Toll Brothers is applying a similar mentality to the luxury segment. However, unlike the more standardized products of their peers, Toll Brothers' approach ensures that buyers in the higher-price tier can still enjoy the personalization opportunities they seek, making their home truly their own.

We are targeting long-term with this new business model of a very wide price point, a very wide geography, about 50% spec, more and more affordable luxury communities, a longer-term gross margin in the 27% to 28% range," Toll Brothers CFO Martin Connor says during the earnings call.

Toll Brothers CEO Yearley emphasized this shift, noting that the company’s spec homes, which accounted for 54% of orders and 49% of deliveries in Q3, offer quick move-in options that still allow for significant buyer customization. This balance between ready-to-own specs and customizable BTO options is especially appealing to the "life happens" segment, where buyers may need immediate housing but still desire the ability to personalize their new home.

Product Range Expansion

Yearley pointed out that the underlying drivers of demand remain robust, particularly among millennials who are now entering their 40s with higher incomes and accumulated wealth—key characteristics of the "life happens" segment. Toll Brothers has strategically expanded its product range to capture a wider market, offering more affordable luxury homes and increasing the availability of spec homes. This broadening of their geographic reach and price points allows them to serve a diverse customer base, including those who require immediate housing solutions due to life changes.

The ability to offer this level of customization at scale sets Toll Brothers apart in the luxury home market. By blending the efficiency of a systems-driven operational model with the flexibility to accommodate a wide array of buyer preferences, Toll Brothers is redefining what it means to deliver a personalized home buying experience in the higher-price tier.

Trevor Allinson of Wolfe Research further validates Toll Brothers' strategic approach. He notes that despite a shortfall in order growth, Toll Brothers exceeded expectations in gross margin performance, which reflects their ability to navigate challenges while maintaining profitability. This focus on gross margin is crucial for attracting the "life happens" segment, who are often less concerned with price fluctuations and more focused on finding a home that fits their immediate life circumstances.

Allinson also highlights Toll Brothers' near-completion of their migration toward a balanced spec and built-to-order model. This balance is particularly beneficial for "life happens" buyers, who may require the quick close of a spec home due to a relocation or other urgent life event, but still appreciate the option to personalize their new home. The ongoing operational transformation at Toll Brothers, which has led to improved efficiency and capital management, positions them to continue attracting this crucial buyer segment.

Sustaining Pace in Diverse Markets

While some markets, such as Texas and Florida, did not outperform in Q3, Allinson emphasizes that gross margins in these regions remain at or above Toll Brothers' company average. This resilience in maintaining strong margins, even in markets with rising resale inventory, further cements Toll Brothers' position as a best-of-breed homebuilder.

Their ability to sustain profitability across diverse geographic markets ensures they can continue to meet the needs of "life happens" buyers nationwide.

A Model for Other Homebuilders

Toll Brothers' success in targeting the "life happens" segment offers a blueprint for other homebuilders looking to navigate today's tricky, volatile market. Their strategic focus on expanding product range, maintaining a balanced spec and BTO model, and emphasizing operational efficiency has allowed them to capture a critical buyer segment that remains active despite broader market challenges.

Our spec strategy is maturing," says Yearley. "We are just about at a point where we've hit the equilibrium of long-term 50% spec, 50% build-to-order and the business plan is in place."

By successfully scaling the concept of "choice" through mass personalization and customization, Toll Brothers has managed to apply a systems-driven approach to the luxury segment, ensuring that even as they streamline operations, they do not sacrifice the personalized experience that defines their brand. For homebuilders seeking to replicate this success, the key takeaway is clear:

Understanding and meeting the unique needs of life-stage buyers — those driven by marriage, new additions to the family, career changes, and other significant life events — is essential. By offering flexibility, personalization, and efficiency, homebuilders can tap into this resilient segment and sustain growth even in a challenging market environment, all by overcoming that "deferral mindset."