Land is expensive, but homebuilders are making it work, Citigroup says

Homebuilders are not being held back by "stubbornly elevated" land costs, according to Citigroup analysts.

The sector is well-positioned for further volume growth into next year, analysts led by Anthony Pettinari said in a note to clients Monday. D.R. Horton Inc. and PulteGroup Inc. saw increased demand this quarter, with net order volumes rising 37% and 24% year-over-year, respectively.

Last week, the sector outperformed the broader market, climbing 1.9% versus the S&P 500's 1.0% advance, as builders continued to post better-than-expected earnings. 

Mortgage interest rate buydowns have allowed homebuilder volumes to run ahead of the market, Citi said. PulteGroup's volumes are supported by its national program, where it typically buys down rates to roughly 5.5%, the note said, adding that the company recently pointed to "demand strength persisting in July, despite benchmark mortgage rates nearing 7% in the month."

"We see opportunity for sequential growth in net pricing as buydowns offset the pain of higher rates, and resale inventories are scarce," the analysts said. 

Taylor Morrison Home Corp., MDC Holdings Inc. and Tri Pointe Homes Inc. expect strength to continue into July, touting sales running in-line with normal seasonality. And while Century Communities Inc. reported some seasonal pressure in July, the company's orders were still up 15% year over year. Meanwhile, M/I Homes Inc. has seen "unseasonably strong" sales.

Tight inventory is also driving up average selling prices. MDC and Tri Pointe Homes reported raising prices in roughly 70% of their communities, while Taylor Morrison Home raised prices in more than half. As demand remains robust, homebuilders have begun reducing incentives in select markets.

Land costs remain a major threat. While land sellers have shown willingness to negotiate in certain markets, the overall market has remained firm, according to Citi.

PulteGroup reported a lack of large-scale opportunities to purchase distressed land, noting that land is "not on sale." And some investors question the sustainability of gross margins in 2024.

However, both PulteGroup and Taylor Morrison Home noted that "while land prices remain elevated, improved activity has allowed them to continue underwriting new land purchases." Similarly, Tri Pointe Homes continues to underwrite new land acquisition to a 18% to 22% gross margin. 

Better pricing, lower lumber costs and shorter cycle times have all supported a gross margin inflection for the industry, the analysts said. Builders that reported in July confirmed margin strength in the second half, with many raising their gross margin outlooks. 

D.R. Horton and PulteGroup expect to see continued improving cycle times, with the latter expecting sequential improvement to continue "well into 2024," Citi said.