Pultegroup Inc

NYSE:PHM

Earnings Call Analysis

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for standing by. My name is Jeannie, and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup, Inc. Q1 2024 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Jim Zeumer. You may begin.

[James Zeumer, executive]

Great. Thanks, Jean. Good morning. Let me welcome everyone to today's call. We look forward to discussing PulteGroup's outstanding Q1 operating and financial results, the period ended March 31, 2024.

I'm joined on the call today by Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; Jim Ossowski, Senior VP, Finance.

A copy of our earnings release and this morning's presentation slides have been posted to our corporate website at pultegroup.com. We'll post an audio replay of this call later today.

I want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports.

Now let me turn the call over to Ryan. Ryan?

[Ryan Marshall, executive]

Thanks, Jim, and good morning. As you read in this morning's press release, PulteGroup reported record first quarter results across many of our key financial metrics. From top line revenues of $3.8 billion, gross margins of 29.6%, to bottom line earnings of $3.10 per share, it was an exceptional quarter. These strong first quarter results helped to drive a return on equity of 27.3% for the trailing 12-month period.

Our strong first quarter results reflect long-term strategic planning and a disciplined capital allocation process that have underpinned PulteGroup's success for more than a decade.

I would suggest that another driver of our record Q1 results are decisions we made in the fourth quarter of last year, decisions that I think are emblematic of the balanced approach we take to running our business and to delivering high returns. On our last earnings call, we talked about decisions we made in the fourth quarter of last year to not lower our prices in a chase for volume. As you will recall, demand in the fourth quarter of 2023 had started slowly but improved as interest rates began to moderate. And we made the decision to push incentives aggressively as the quarter progressed, we likely could have delivered higher closing volumes in '23.

With demand improving in the fourth quarter, we elected to hold our pricing and have had more inventory available for the 2024 spring selling season. The result of this decision is that we were in a position to sell and close more homes in the first quarter of 2024 and at higher margins. That's what you see in our Q1 results. closings and gross margins above our guide as demand dynamics allowed us to sell more homes with better net pricing.

When buyer demand is rising, we're often asked how many more homes we can sell. Given the value we place on entitled lots and our focus on driving high returns, more volume is not the only answer as we work to balance pace and price to drive high returns. Within our operating model, stronger demand provides choices. We can sell more houses or we can raise prices, or as was the case in the first quarter, we can do both.

What we experienced in the first quarter is that areas of strong demand last year, such as the Southeast, Florida and Texas, continued to perform well into 2024. Even more positive is that areas that had some struggles in 2023, notably, Arizona, California and Nevada, were much improved in 2024. Consistent with the favorable conditions in the first quarter, almost all our markets displayed pricing dynamics that were stable or improving, which allowed us to raise net pricing in more than half of our communities.

As you've heard us say many times, our pricing decisions are made with the goal of delivering high returns and the best overall business outcomes. Depending upon the community and the buyers' wants and needs, we may have raised base prices or lowered incentives. The result being that net pricing in the quarter across many of our markets was up between 1% and 5%.

The impact of these actions on our business performance is powerful. As Bob will discuss, we are increasing guidance for both full year closings and gross margins. Against generally favorable demand conditions, the supply of available housing remains tight. We have the long-term structural issue resulting from a decade of underbuilding that has the country's short approximately 4 million housing units. At the same time, the available inventory of existing homes for sale continues to be low as homeowners remain locked into their low mortgage rates.

Life happens, so we are seeing some additional existing homes come to market, but the numbers remain well below historic rates.

As a homebuilder, this is a great operating environment as we are supplying a product that a lot of people need and want. I appreciate, however, that our country's housing shortage can create hardships for today's consumers as the lack of supply keeps housing prices high. In fact, some of our recent buyers said that they made the decision to buy now because they couldn't wait any longer for rates to roll back.

In a market where home prices are high and because of limited inventory, they will likely continue moving higher. Our company's ability to offer targeted incentives, particularly mortgage rate buydowns, is a powerful tool that can help bridge the affordability gap. For example, in the first quarter, approximately 25% of our homebuyers used our national rate program. In a world where the consensus is that interest rates will be higher for longer, our interest rate incentives likely become an even greater competitive advantage, especially relative to the existing home seller.

Higher interest rates create additional challenges for today's homebuyers, but we appreciate that rates are moving higher because of a resilient economy and a strong job market. Given these conditions, we are optimistic about 2024 and PulteGroup's ability to continue delivering strong financial results.

Now let me turn the call over to Bob for a review of our first quarter results. Bob?

[Robert Shaughnessy, executive]

Thanks, Ryan, and good morning. As Ryan noted, the company delivered exceptional operating and financial results in the quarter, which have us well positioned to realize outstanding financial performance throughout 2024. In the first quarter, we reported home sale revenues of $3.8 billion, which represents an increase of 10% over the prior year's first quarter.

Higher revenues in the period were driven by an 11% increase in closing to 7,095 homes, partially offset by a 1% decrease in average sales prices to $538,000. The lower closing price compared with the first quarter of last year reflects a shift in the geographic mix of homes closed as we realized relatively higher closings from our Southeast and Florida markets, with more modest increases in our higher-priced Western markets.

Closings in the quarter came in above our guide as we had available spec inventory to meet the strong buyer demand we experienced in the period. As Ryan highlighted, by choosing not to chase volume in last year's fourth quarter, we had additional inventory in Q1 that we were able to sell and close with better margins due to the improving buyer demand activity in the quarter.

Our spec production is predominantly within our first-time buyer communities. So on a year-over-year basis, we realized increased closings from first-time buyers.

In the quarter, our closing mix included 41% first time, 36% move-up, and 23% active adult. In the first quarter of last year, the mix of closings consisted of 38% first time, 36% move-up, and 26% active adult.

Reflecting the favorable demand conditions we experienced in the first quarter, net new orders increased 14% over last year to 8,379 homes. In the quarter, we realized a year-over-year increase in gross orders and a reduction in cancellation rates. Cancellations as a percentage of starting backlog fell to 10.1%, down from 12.7% in the first quarter last year.

Average community count for our first quarter was 931, which is an increase of 6% over the prior year and in line with our guidance for year-over-year community count growth of 3% to 5%. The resulting absorption pace of approximately 3 homes per month for the quarter was above our historic average for the period, excluding the pandemic impacted years of '21 and '22.

I would also like to highlight that orders in the quarter were higher across all buyer groups, which is another sign of the overall strength of the market. More specifically, net new orders among first-time buyers increased 8%, move-up increased 22%, and active adult increased 12%. Consistent with earlier comments, the large increase in orders among move-up buyers was influenced by improving market conditions in the West where our business mix is much more heavily weighted towards move-up.

Given this strong start to our spring selling season, our quarter-end backlog increased to 13,430 homes with a value of $8.2 billion.

We started approximately 7,500 homes in the quarter and ended the period with a total of 17,250 homes under construction. Our production pipeline includes approximately 7,000 or 41% spec homes, of which 1,337 are completed. We are operating just above our target of 1 finished spec per community, but believe carrying a few more finished specs is the right strategy given buyers' preferences and the fact that we are still in the more active spring selling season.

Given the units we have under construction and their stage of production, we expect to close between 7,800 and 8,200 homes in the second quarter. With a strong start to the year in both quarters and closings, we are raising our guide for full year closings to approximately 31,000 homes. This would represent an 8% increase over 2023, which is at the higher end of our long-term goal of growing our closing volume between 5% and 10% annually.

Closings in the first quarter had an average sales price of $538,000, which was slightly below our guidance for pricing of $540,000 to $550,000. Relative to our guide, pricing in the quarter was influenced by the geographic mix of closing, along with a higher volume of spec homes closed in the period. As we move through the remainder of the year, we expect the mix of homes closed in each quarter will result in ASPs consistent with our prior guide of $540,000 to $550,000.

For the first quarter, we reported a gross margin of 29.6%, which is an increase of 50 basis points over the first quarter of '23 and a sequential gain of 70 basis points from the fourth quarter of '23. At 29.6%, our first quarter gross margin was also notably higher than our guide. Beyond Ryan's comments that we were achieving high returns by actively managing both pace and price, mix had an impact on our reported Q1 margins. Higher demand increased in the quarter as the quarter advanced, which allowed us to sell and close more homes in the period than forecasted. On a relative basis, more of these closings occurred in our higher-margin markets in the Southeast and Florida, resulting in a meaningful increase in reported gross margins for the quarter. Based on Q1 sign-ups and the composition of our backlog, we would expect the geographic mix of closings to be more balanced as we move through the remainder of the year.

That being said, we're raising our gross margin guide for the remainder of '24. We had previously guided to quarterly gross margins of 28% to 28.5%, but we now expect gross margins in the second quarter to be approximately 29.2%. Based on current backlog, we expect gross margins in the third and fourth quarters to be approximately 29%, but we still have homes to sell and close. So demand conditions over the coming months will impact the results we ultimately report.

Beyond buyer demand and near-term pricing dynamics, the gross margin guide for the remainder of '24 also reflects expected changes in the geographic mix of homes we expect to close. Given recent sign-up trends, we anticipate closing more homes in our West region, which currently have a lower relative margin profile due to the fact that we adjusted pricing in these markets over the course of '23 to achieve appropriate sales paces.

Looking at our costs. Reported SG&A in the first quarter was $358 million or 9.4% of home sale revenues. As noted in our press release, our reported SG&A for the period includes a $27 million pretax insurance benefit. SG&A in the first quarter of '23 was $337 million or 9.6% of home sale revenues. Consistent with our previous guidance, we continue to expect SG&A expense for the full year to be in the range of 9.2% to 9.5% of home sale revenues. Based on normal seasonality, we expect to realize increased overhead leverage as we move through the remaining quarters of the year.

Our Financial Services operations reported a pretax income of $41 million for the first quarter, which is an increase of almost 200% from last year's pretax income of $14 million. The increase in Q1 pretax income was driven by better market conditions across our Financial Services platform. Financial Services also benefited from higher capture rates across all business lines, including an increase to 84%, up from 78% last year, in our mortgage operations.

As noted in this morning's press release, in the first quarter, we completed the sale of a joint venture that resulted in a gain of $38 million. On our income statement, this gain was recorded in equity income from unconsolidated entities.

Our reported first quarter pretax income was a period of record of $869 million, an increase of 24% over last year. Against that, we recorded tax expense of $206 million, which represents an effective tax rate of 23.7%. Our reported Q1 tax rate was impacted by energy tax credits and stock compensation deductions recorded in the period. For the balance of the year, we continue to expect our tax rate to be in the range of 24% to 24.5%.

In total, our reported Q1 net income was $663 million or $3.10 per share, compared with prior year reported net income of $533 million or $2.35 per share. Earnings per share in our most recent quarter benefited from a 6% reduction in share count compared with the prior year as we continue to systematically repurchase our stock.

Moving past the income statement, we invested approximately $1.1 billion in land acquisition and development in the first quarter. Consistent with our recent land activity, 60% our land spend in the quarter was for the development of our existing land assets. Our Q1 land spend keeps us on track with our plan to invest approximately $5 billion in land acquisition and development for the full year, of which we continue to expect about 60% will be for development, with the remainder for the acquisition of new land positions.

We ended the quarter with approximately 220,000 lots under control, of which 51% were held via option. The purchase of several large land positions in combinations with decisions not to move forward with option transactions during the quarter lowered our lot option percentage from the end of 2023. I would highlight, however, that 74% of the lots we have approved in this most recent quarter were under option. As our first quarter numbers in the key, we continue to work toward our multiyear goal of controlling 70% of our land pipeline via options.

Looking at our community count, we continue to expect average community count in 2024 to increase 3% to 5% in each quarter over the comparable prior year period. Along with investing in our business, we continue to return capital to shareholders. In the quarter, we repurchased 2.3 million common shares at a cost of $246 million or an average price of $106.73 per share. In the quarter, we also opportunistically purchased approximately $10 million of our outstanding bonds. After allocating approximately $1.4 billion to investment in the return of funds to shareholders, we ended the first quarter with $1.8 billion of cash.

Taking all of this into account, our quarter-end gross debt-to-capital ratio was 15.4%, while our net debt-to-capital ratio was only 1.7%.

Now let me turn the call back to Ryan for some final comments.

[Ryan Marshall, executive]

Thanks, Bob. As you would expect, given the strength of our first quarter results, buyer interest was high in the period as the order pace has increased beyond typical seasonality. That sales momentum continued into April, although we are now seeing some moderation of traffic into our communities due to the recent increases in interest rates, particularly within the Centex brand. While the change is relatively modest and based on a limited number of days, consumer feedback suggests that higher rates are causing some buyers to evaluate the timing of their activity due to the volatile interest rate environment. We'll continue to monitor how buyers respond to changes in the rate environment and are prepared to adjust pricing or incentives to ensure we are appropriately turning assets.

During our last earnings call, we talked about the opportunity for PulteGroup to grow its business 5% to 10% annually. Given the lengthy land investment process, organic change in this industry takes time to accomplish, but we have been systematically planning and positioning to deliver against this goal for the past few years. I think that the company's efforts are reflected in the allocation of capital into growing our business. Including our Q1 spend since 2021, our operating teams have invested approximately $14 billion in land acquisition and development, with plans to invest another $5 billion in 2024.

Along with the land, we have been investing in our people and working to ensure the needed trade capacity is available to support our expanding operations. I'm proud to say that we've accomplished this while adhering to the same underwriting hurdles and investment disciplines which have been the cornerstone of PulteGroup for the past decade. Such discipline has allowed PulteGroup to more consistently grow its earnings, drive substantial cash flow from operations and deliver high returns.

And we've accomplished this while maintaining the superior build quality and customer experience which PulteGroup homebuyers have come to expect.

Before opening the call to questions, I want to take a minute to recognize and celebrate our team for once again being named a Fortune 100 Best Company to Work For. What makes this recognition so important and gratifying is that it's based on feedback from all of our employees. This marks PulteGroup's fourth consecutive year on the list and is a testament to the culture of personal caring and professional development that we work to maintain. I am proud to lead such an organization that is committed to taking care of our customers and each other.

Let me now turn the call back to Jim Zeumer.

[James Zeumer, executive]

Great. Thanks, Ryan. We're now prepared to open the call for questions so we can get to as many questions as possible during the remaining time of this call. [Operator Instructions]

[Operator]

[Operator Instructions] Your first question comes from the line of Stephen Kim with Evercore ISI.

[Stephen Kim, analyst]

Impressive results, and I appreciate all the guidance that you provided. I guess my first question relates to your longer-term targets with respect to land. Ryan, I think the last time I asked you this question, I was curious about sort of where your long-term target is, and I think I stated it in terms of year zones. I understand that you want to have about 7 years controlled with about 30% options over the long term. That would put you at about a little over 2 years of owned land. You're quite a bit above that now?

And so my question is, am I thinking about that right? Is your long-term target for owned land a little over 2-year zoned?And over what time span do you think we should expect you to migrate to that, if that is, in fact, your target?

[Ryan Marshall, executive]

Yes, Stephen, thanks for the question. I think your overall target of 7 years control is about right. And then we stated our long-term target of optionality at 70%. We do think it will be a multiyear journey in getting there. And that's really driven by the fact, Stephen, that we want to do it in a very organic, natural way that drives ideal economics for each individual transaction.

We highlighted in the prepared remarks, Bob did, that in the quarter, 74% of the deals that we approved were under option. We think that type of activity over the next several years will have us arrive at our long-term target in a very natural way. When we do that, to your point, we'll be right around something just over 2, 2.5 years of owned land at that point.

[Stephen Kim, analyst]

Yes. And then as you progress in that manner, it will unlock some additional cash flow in addition to your net earnings. And so I wanted to turn to cash flow next. I think you gave a guidance -- a guide for cash flow from operations for the full year previously at about $1.8 billion. You've taken up -- you had a great 1Q, you've taken up your outlook for both volume and gross margin and, let's just say, operating margin, for the year. Can you give us an update on where you're thinking cash flow from operations may come in for the full year in light of those changes? And maybe even more importantly, what should we expect in terms of deployment into dividends and repurchases? I noticed this quarter, for example, like it was pretty much -- buybacks was pretty much equal to cash flow from operations. And your leverage has pretty much stabilized in low single digits. So is it right to think that maybe whatever you're generating cash flow from operations, with a little bit of flex quarter-to-quarter, but in general, that's about what you would deliver in terms of repayment -- sorry, repurchases and dividends?

[Robert Shaughnessy, executive]

Yes, Stephen, it's Bob. We didn't update the guide on cash flow. It's early in the year. We're thinking about what we're investing in the business. You can see, if you look at the balance sheet, just since the end of the year, we're up about $300 million in investment in the balance sheet, roughly half land, half house. And so to your point, we certainly expect, with incremental volume and incremental margin, that we'll generate a pretty healthy amount of cash. Some of that will be invested to meet that 5% to 10% growth that we've talked about. So more to come on that as the year progresses, certainly. But I think the bias would be for more cash from operations.

And to your point on capital allocation, I think we've been pretty consistent, right, for the last 10 years since we laid out our strategy for capital allocation. A, invest in the business, pay a dividend that grows with earnings, buy back stock with excess capital against a modest debt profile. Obviously, the leverage is lower than we had anticipated. We look at liability management as part of our capital allocation.

So I don't know that I'd go so far as to say cash flow from operations will equal repurchase activity. I think we've been pretty clear, we're going to report the news on what our repurchases are going to be. But we obviously, in a world where we're generating cash at that level, particularly if we have less invested in the balance sheet as we move towards that 70%, it will free up capital, and we'll work through what to do with that capital as we generate it.

[Stephen Kim, analyst]

Okay. Well, we'll be staying tuned. Congratulations on the strong results?

[Operator]

Your next question comes from the line of Matthew Bouley with Barclays.

[Matthew Bouley, analyst]

So in the fourth quarter, you, as you mentioned, sort of didn't raise incentives to chase volume. Now speaking to rates being higher for longer, eventually we'll be past the peak of the spring demand and all that. So I guess going forward, how are you thinking about that trade-off with incentives from here? Given where your margins are, is there an opportunity to perhaps trade a little bit of that margin to drive better growth, obviously, in the context of supporting returns?

[Ryan Marshall, executive]

Matt, it's Ryan. Thanks for the question. We've said in the past, we're not going to be margin proud, and I would tell you that remains true. As we highlighted in some of my prepared remarks today, we believe our operating platform and how we've positioned our specific community investments, we're in a great position to command excellent pricing, get pace and price, which you saw in this most recent quarter.

We -- given the interest rate environment that we are clearly going into higher for longer, we've got the ability to use the very powerful tool of forward mortgage rate commitments that allow us to offer a pretty attractive pretty attractive incentive program. Right now, we're at 5.75% nationally, and about 25% of our buyers are taking advantage of it.

The other thing I'd highlight is that 60% of our business is move-up and active adult, which tends to not be quite as rate-sensitive as the first-time buyer. With that first-time buyer, that's where predominantly our Centex brand, predominantly first-time buyers, and we see a higher percentage of those buyers take advantage of the forward rate commitments.

The last piece, Matthew, that I'd probably point out is that our guide for the balance of the year assumes that the incentive load that we currently have, which on the most recent quarters closings was running at 6.5%, we've assumed that that stays flat going forward.

[Matthew Bouley, analyst]

Got you. Okay. Second one, I wanted to move to the topic of land costs and land inflation. I think last quarter, you had spoken to the potential for mid- to upper single-digit inflation in land, but maybe wasn't totally clear on exactly when that would impact your gross margin. I'm curious, can you kind of walk us through the timing of sort of land costs flowing into your gross margin? And then kind of what are you seeing in real time in the land market? Has the market started to decelerate at all or is it kind of still kind of chugging along at that mid-upper single-digit rate?

[Robert Shaughnessy, executive]

Yes, Matt, it's Bob. That mid- to high single-digit increase in our lot cost was in our Q1 and is expected to continue through the balance of the year. So when we gave the margin guide, we had pretty good visibility into our lot cost because those are lots typically on the ground already, so it's there.

In terms of the current market conditions, it's still competitive out there. I've said this before, land hasn't gone on sale, and slight variations in market typically don't result in prices declining. The market is super efficient on the way up, a little bit sticky on the way down. So for quality parcels, it's competitive.

[Operator]

Your next question comes from the line of Carl Reichardt with BTIG.

[Carl Reichardt, analyst]

I think this is the first time since mid-2020 when you haven't addressed construction cycle time. So I thought at least I'd ask. Across the markets, products and geographic markets, are cycle times effectively normalized now for you? Or are we still a little bit longer than you were pre-COVID?

[Ryan Marshall, executive]

Carl, thanks for the question. We saw a couple of days of cycle time improvement in the most recent quarter. So we were at 128 days, down from the 130 that we ended the fourth quarter of 2023 in. We are still on track and still are targeting being at 100 days by the end of the year?

When we look deeper at our Q1 numbers, we had some long cycle to closings that had been in production for a long time, in many cases, were multifamily and condo buildings, that we think kept the overall number that I just shared with you of 128 days a higher -- a little bit higher than what we think is our actual run rate at this point.

When we look at a lot of our markets, we're already back to kind of pre-COVID cycle times of even sub-100 days. So we've made a lot of progress in a lot of places.

We have a few markets that are a little stickier where we're working hard to get cycle times back to where we'd like them to. But by and large, we still feel that the target we've set of 100 days is very much in reach.

[Carl Reichardt, analyst]

Great. And then you talked a little bit about existing home inventory creep that I think we're seeing in some of the data. If we dig into that, Ryan, if you can dig into that, is this inventory that you'd expect would be effectively a net neutral impact to the demand/supply? In other words [indiscernible] to move elsewhere, versus vacant capacity, meaning investors or second homeowners who are putting their homes on the market effectively vacant? Because I think there's an important difference between the 2. So to the extent that you know, what are you seeing?

[Ryan Marshall, executive]

Yes. outside, there might be -- I'm sure there's some markets, Carl, where there is vacant investor-driven inventory that you could characterize as new supply. The majority of the markets where we operate, we think any existing resale inventory that does come to market, those are buyers that are going to go buy another home somewhere else. So we think it's largely neutral on the overall supply side.

[Operator]

Your next question comes from the line of Anthony Pettinari with Citi.

[Anthony Pettinari, analyst]

I was wondering if you could talk about maybe the potential impact of the NAR settlement on your business or maybe the broader industry, and any kind of potential secondary impacts to Pulte?

[Ryan Marshall, executive]

Yes, Anthony, we're watching it closely, as I think a lot of the real estate world is. Where we think it ultimately goes is it will create better transparency around the fee structure and will likely change over time the way that the providers of those services charge the users or the consumers of those services ultimately pay.

So we -- realtors are an important part of our business, and over probably 60% of the sales that we have include a buy-side realtor involved. So we certainly support the realtor community. They've been an important part of our company for a long time. But we are watching the way that the landscape there will certainly change.

[Anthony Pettinari, analyst]

Okay. And then you talked about stronger trends regionally, I think in Nevada, Arizona, California, if I got that right. Is there anything particularly driving that in your view? And maybe if you can just talk about the kind of long-term attractiveness of that region as you kind of build out the community count?

[Ryan Marshall, executive]

Yes. A couple of things happened there. It was a market that saw a lot of price appreciation in the COVID years. Affordability, we think, got strained, for certain. Last year, we did a fair amount of price discovery as we worked to rightsize what our go-to-market price was in those markets. That, combined with, I think, a general improvement in buyer sentiment, contributed to the lights coming back on in the Western market.

So some of the markets that we'd highlighted pretty consistently last year, Seattle, Northern California, Southern California, Las Vegas, Phoenix, those were strong contributors to our overall results in this most recent quarter.

We'd expect that to continue. Bob highlighted that the relative margin contribution out of those markets will be lower than some of the other parts of our business. We've incorporated that incremental volume that we're getting at a slightly lower margin contribution profile into our guide.

So we're -- look, we're pleased that those markets are contributing. We got a lot of capital invested there. They're big housing markets. People want to live there for a number of reasons: climate, jobs, et cetera. So we're pleased that they're doing well.

[Operator]

Your next question comes from the line of Michael Rehaut with JPMorgan.

[Andrew Azzi, analyst]

This is Andrew Azzi on for Mike. A quick one. I just wanted to drill down, if I could, on the demand trends you've been seeing over the last few months, just given the change of rates and some concerns in the market, I'd love any kind of progression you saw in the quarter and here into April.

[Ryan Marshall, executive]

Yes. It was a strong quarter, a strong first quarter. We highlighted that we saw some trends that were even stronger than normal seasonality. We -- the first few weeks of April have continued to show signs of strength. We did highlight that, as we look at traffic, new traffic that's coming into the stores, while a limited number of days in that data set, we are seeing a small downturn that we think is reflective of the change in the rate environment.

So we're going to keep an eye on it. We don't, at this point, think it's anything to be too learned about, but we're watching it.

[Andrew Azzi, analyst]

Great. And then, I guess, secondly, on the material costs, how have these kind of trended? And any kind of detail and how that's reflected in your 2Q gross margin, kind of your assumptions for [ stick ] and brick costs?

[Robert Shaughnessy, executive]

Sure. Build costs, they were stable in the first quarter, about $80 a square foot for base house. That's flat with Q4 of '23. It's actually down from $84 a square foot in the first quarter of last year. As we look at '24, we expect cost inflation in labor, materials to be pretty manageable with low single-digit increases, and we factored that into our guidance.

[Andrew Azzi, analyst]

I appreciate it. Congrats on the quarter.

[Operator]

Your next question comes from the line of John Lovallo with UBS Financial.

[John Lovallo, analyst]

So the revised full year full year gross margin outlook is about flat year-over-year. And I think previously, you had talked about pricing being kind of flat year-over-year. That was a little bit better in the first quarter, for sure. Mid- to high single-digit land cost depreciation, kind of low single-digit construction cost appreciation. Just curious how you guys are managing that to actually achieve a flat year-over-year gross margin in that kind of cost environment with what had previously been expected to be sort of flattish pricing.

[Robert Shaughnessy, executive]

Yes. I think it's the strength of the market, John. We highlighted that we're raising prices in a number of our communities, that 1% to 5%. That's really the driver combined, certainly in this first quarter, with the mix differential that we had highlighted.

[John Lovallo, analyst]

So is it pricing -- just pricing and mix a little bit better than previously expected?

[Robert Shaughnessy, executive]

Yes. Just to be clear, John, the mix was really a Q1 issue. We think that spools out based on the relative strength of volume that Ryan highlighted out West. So we'll get more of that relatively lower margin profile in the back half of the year.

[John Lovallo, analyst]

Okay. And that was sort of my follow-up is, if we think about the positive mix impact in the first quarter, I mean, how much of the slight step-down from 29.6% to 29.2% in the gross margin outlook for the second quarter, is the reversal of that mix impact? Or is that really more of a back half phenomenon?

[Robert Shaughnessy, executive]

It's both, right? But you'll see some of it in Q2 based on the sales that we did in the first quarter, and then you'll see more of it later in the year. That's part of the reason for the step-down, margin.

The other thing that we highlighted on the call, we still have a lot of homes to sell for the back half of the year. And so the point we were making is we -- it depends on how the demand environment holds up. If it does, that's good. If the market changed, you could see plus or minus depending on whether it's the positive change or a negative change.

[Operator]

Your next question comes from the line of Sam Reid with Wells Fargo.

[Richard Reid, analyst]

Thanks for the incremental color on April, especially the traffic detail. I mean it definitely makes sense that the Centex buyer is a bit more rate clash payment sensitive. But I wanted to drill down on this a bit more and maybe see if you had any perspective on traffic across other parts of your business, that 60% that's kind of active adult and move-up? And what you're seeing from that buyer cohort, if anything, as rates move?

[Ryan Marshall, executive]

Sam, we don't -- we're not parsing the traffic data quite that finally for the purpose of this call. One other data point that I will tell you, while we've seen -- while we've seen traffic into the stores moderate over the last several days, traffic to the website has been incredibly strong. So we still think that there's high buyer demand and desire for homeownership. Certainly, anytime there's rate fluctuations, that can cause some disruption in buyer behavior. But we think the fundamental or the overall demand for housing remains incredibly strong, and we're still in a very supply-constrained environment.

So the overall thesis about this has been a strong operating environment for the industry and this company in what's been a pretty high interest rate environment. We think the environment that we would expect for the balance of the year, we can continue to show success in that type of situation as well.

Affordability is, there's no question, it is the headwind that we'll continue to navigate for the balance of the year, and we think we've got the tools to do that.

[Richard Reid, analyst]

No, that's helpful. And then maybe switching gears here. It's been a little while since this topic has come up. But can you talk to your relationship with Invitation on the single-family rental side? And give us an update on where things stand, perhaps how many homes you're looking to sell to them this year? Any color there would be great.

[Ryan Marshall, executive]

Yes. We targeted when we kind of kicked off the philosophy or the strategy that we had on single-family rental with Invitation Homes. And we also partner with some other local single-family rental operators as well. We've targeted to be somewhere around 5% of our total volume would go into the single-family rental kind of channels. The current year, the closings that we have that will go into that pipeline are right kind of in that 5% range.

Certainly, the interest rate environment currently, I think, makes it harder for the single-family rental operators to underwrite their deals. We wouldn't expect that to necessarily be the case forever. But in the kind of right here and now, a little harder to make those deals pencil for those [ SFR ] operators. It's part of the reason that we've said we want it to be part of our business, but not such an outsized component that it creates disruptions on how we operate.

[Operator]

Your next question comes from the line of Rafe Jadrosich with Bank of America.

[Rafe Jadrosich, analyst]

I was wondering if you could talk a little bit about on the cost side, what are you seeing today in terms of the cash cost of the -- for land and materials, relative to what's flowing through your P&L? And what's kind of the outlook on the cost side?

[Robert Shaughnessy, executive]

Well, certainly, on the material side, it is pretty consistent. And as Jim highlighted, build cost per foot flat. The only thing where we're really feeling any pressure there is on OSB, which has run up a little bit.

In terms of the land, we've highlighted that high single-digit increase in lot cost, that is candidly continuing a theme that has been going on for a number of years. And it's likely to persist. We -- I've often described it as a conveyor belt of land. And we have 3 years of lots that we buy at any -- or control at any one point in time, and they kind of roll on the most recent year falls off. Every new year coming on is a little bit more expensive, and that's a combination of increased land cost and increased development costs. But we haven't seen a step change in that, if that's really what you're focused on. So again, I think you can and should expect to see our lot cost going up for the foreseeable future.

[Rafe Jadrosich, analyst]

Got it. That's helpful. And then just looking at the first quarter gross margin, can you just talk about the drivers of the quarter-over-quarter -- the 70 basis points quarter-over-quarter step up? And then what was the upside to your initial guidance?

[Robert Shaughnessy, executive]

Sorry, was that -- are you asking sequentially or year-over-year?

[Rafe Jadrosich, analyst]

Sequentially.

[Robert Shaughnessy, executive]

Yes. So you've got 70 basis points. Certainly, a part of that is going to be the strength of -- relative to our guide, of the strength of the market, where for the spec homes that we sold, we got better pricing, which was a relative margin benefit over the fourth quarter. And the other thing is the mix shift, not just in terms of geography, which we had highlighted, but on a sequential basis, we also had a mix shift towards move-up which has this higher margin profile relative to first time, which is where the margin came from. They have -- I hate to use this, but there's mix and there's a couple of different mixes going on. But when you're looking at the sequential margin performance, certainly, it's the strength of the market relative to what we thought coming into it, and also, it's a little bit more move-up, which has a higher margin profile for us.

[Operator]

Your next question comes from the line of Mike Dahl with RBC Capital Markets.

[Michael Dahl, analyst]

I'm going to stick with margins. Bob, you kind of alluded to this. It's a tricky time when you've just had this rate move. You're maybe just on the front end of seeing some traffic impacts that you're having to give guide out a few quarters. And so I appreciate that there's still some uncertainty when you've got 1/3 of your full year closings yet to be sold.

So maybe just talk through the assumption for flat incentives against this move in rates. Just talk about kind of why that was -- why that is kind of the baseline assumption or if it just felt like kind of the right placeholders and matches kind of what your backlog margins look like today? Maybe just a little more detail on how you went through this process that kind of an odd time when the rate move just happened?

[Robert Shaughnessy, executive]

Yes, it's interesting. I'd refer back to something Ryan offered, which is that affordability is still a challenge. And so it gets that backdrop. Our expectation is that we will need to continue to incentivize folks. And the predominant way we're doing that today is through our national commitments and some sort of rate [ band ] support.

So our expectation is that, that continues. That was our expectation coming into the year. In the first quarter, you all have heard us say, it was 6.5%, again, just like the fourth quarter, that's roughly $35,000, $40,000 a house. In a world where rates are actually trending back up, I think that we're going to need to continue to support that.

So it's a little bit challenging, to your point. But I think on balance, our expectation is that's where we're going to need to be to meet some of the affordability needs. It's one of the reasons we think you'll continue to see this strong market performance on a relative basis of new versus resale, because we can offer those incentives.

[Michael Dahl, analyst]

And I guess as my follow-up, more specifically, that kind of implies that you'll get your advertised rates float up over time to match what the market move is and maintain your relative incentive. And so if you're allowing your rate to kind of float up, call it, 40, 50 basis points from where it may have been a month or 2 ago, what have you done or seen in terms of kind of thinking about sensitizing some of the recent demand trends, particularly in your Centex brand? I understand that it's not going to be a major, potentially, not as major a dynamic for your move-up or active adult. But in your Centex brand, what's the sensitivity to a 40, 50 basis point move in rates that you've kind of seen or thought about?

[Robert Shaughnessy, executive]

Well, certainly, for that true entry-level buyer, it's the game, right? And so we've got programs that offer them lower cost incentives, so we're giving them more rate support, relative to others who have choices. And it's worth it to remember we offer a national program, but there's a lot of detail in terms of what we can and actually do offer to people and what they want to kind of access in terms of our support. There will be some people with rates moving up that will literally fall off the ability to buy a home. That's not the case for our active adult and move-up buyers, and candidly, for a lot of our Centex buyers. You look at our average sales price at $419,000 in this most recent quarter, that's not typically your true entry-level buyer. We're at a little bit higher price point. Our first-time communities are typically a little bit closer in. And so I think it depends on who your buyer is.

But to answer your question about will we vary our offering? The answer is yes, we have been. We are actively managing these national programs. We're buying commitments in relatively small amounts so that we don't get caught by market changes. And what it allows us to do is change our offering based on what the market is doing. So as the market rates floated down, we moved our offer rate down somewhat to try and be responsive to deliver a real savings versus the street rate that they could get on their mortgage. As rates tick back up, we're moving those rates up a little bit.

It's an art, not a science. But I think what you could expect us to do is listen to the consumers in terms of what they need, and seek to offer them programs that give them what they need.

[Operator]

Your next question comes from the line of Alan Ratner with Zelman & Associates.

[Alan Ratner, analyst]

Thanks for sneaking me in here. Nice quarter. So would love to get your updated thoughts on specs versus build-to-order? I know you and others kind of ramp the spec production as cycle times re-elongated and there was a premium or at least kind of that margin differential, spec versus BTO was kind of smaller than it historically has been. I'm just curious if you're thinking about that any differently today with cycle times continuing to normalize and rates seemingly being higher for longer. It sounds like maybe the Centex offering, which is predominantly spec, I would think, is maybe seeing more of that impact from the move-in rates. So are you at the point now where you are kind of dialing back the spec starts a bit? Or do you still want to maintain the current mix of your business?

[Ryan Marshall, executive]

Yes. We're pretty happy with where we're operating. And we look at a couple of -- I mean, the first thing we look at is what's the percentage of build-to-order versus spec sales. Right now, it's running around 50-50. And then we highlighted in Bob's prepared remarks, 40% of our WIP is spec, and we've got a little bit higher than 1 final per active community.

So we pay attention to it closely. It's something that we spend a lot of time managing and being responsive to what we're seeing in the market. To your point, most of our spec -- or Centex business is spec. We certainly have a little bit of spec in the other 2 brands, but Pulte and Del Webb tend to be more of a build-to-order kind of model, and we're certainly responsive to that as well.

So we're going to watch it, but in a higher interest rate environment, having available specs that you can more efficiently and effective apply the most powerful incentive to in the form of the forward mortgage rate commitments, you can do that better on spec inventory, which makes it more attractive. So you'll probably see us stay pretty close to where we're at.

[Alan Ratner, analyst]

Great. Appreciate your thoughts there, Ryan. And then pivoting to kind of the incentive environment, I think, obviously, you guys certainly made the right call by not chasing the market lower in the fourth quarter based on your performance this quarter. It sounds like from your guide, for flattish incentives, you're not expecting to have to ramp discount as the selling season kind of moves into its later stages. But what is the sensitivity you're looking at there? How much longer will the more recent, I guess, softer traffic trends or maybe sales activity, how long would that have to persist before you would sit there and say, you know what, we need to maybe increase those incentives a little bit to bring up the sales pace? Is it a few months? Is it kind of getting past the peak of the selling season and you're sitting on more inventory than you'd like? What's the decision process there look like?

[Ryan Marshall, executive]

Yes, Alan, we look at sales rates every single day. It's one of the first e-mails that I look at, is what had sales for the prior day come in at. And we look at qualitative and quantitative feedback that we get from our field operations in going through that decision-making process.

What I can tell you is the change in rate, never mind what it was and never mind what it's going to, just the mere fact something changed, we've seen that cause pauses in buyer behavior over the last -- or last 24 months. Any time there's been a step change in rate and the media cycle that goes with it, that certainly has a pretty profound impact on buyer behavior.

Time does seem to cure it. The only thing that I would continue to kind of caveat, put out there is that affordability continues to be a real issue. And so we've got to balance the change there.

We think one of the things that we're going to continue to do is pay attention to what the headline rate is. And Bob talked about that a few questions ago. Our national mortgage rate incentives have got the flexibility to move based on what the market is doing. So we still think we can have a compelling offer out there relative to the street rate that doesn't necessarily cost us a whole bunch more relative to what we're currently paying.

The last pace -- the last piece, Alan, is we are going to keep our production machine moving. We are a production builder. And we're going to do that in a way that we think optimize this kind of return. So if there are price changes or discount changes that ultimately have an impact on affordability that allow us to continue to turn the asset and keep the market share that we have, we'll definitely do that.

[Operator]

We have reached the end of the call, and we'll take our final question from Ken Zener with Seaport Research Partners?

[Kenneth Zener, analyst]

I wonder if you could just give some context on the regional comments you made, and want to narrow it down to Florida, because it's a segment that obviously generates quite a bit of your EBIT. Can you, within Florida, talk about how that existing market supply rising affected, let's say, the Centex versus your move-up brands, realizing Orlando's different than coastal markets, but it's such a big market for you guys profitability-wise. If you could maybe give a little color related to the margin swings, you kind of staying with those trade-up buyers, entry, within markets that are seeing the pickup in inventory specific to Florida?

[Ryan Marshall, executive]

Yes, Ken, I want to make sure that I understood kind of the full question. Maybe I'll give you a little bit of Florida commentary, and then if there's more follow-up, I'll let you ask that.

Florida is a tremendous part of our business. We're in nearly every major housing market there, save Miami. And a big part of our business there tends to be focused on move-up and age targeted. We have some entry-level business in our Tampa and Orlando businesses, but the other big markets are predominantly move-up and age-targeted. We get a little bit of a move-up in Jacksonville as well -- or a little bit of entry level in Jacksonville as well.

So really strong business. A lot of job relocation there. A lot of folks that want to be there because they've got flexible work arrangements that allow them to work from home or work from elsewhere.

The headwinds in Florida are definitely affordability. We've seen strong price appreciation in most Florida markets. And then the other kind of headwind that you've got there is around property taxes and insurance. So certainly, those things kind of play into that, but Florida continues to be a big part of our business and a real bright spot for our business as well.

[Kenneth Zener, analyst]

That was sufficient. Thank you very much.

[Operator]

I will now turn the conference back over to Jim Zeumer for closing remarks.

[James Zeumer, executive]

Great. Appreciate everybody's time today. We're around the remainder of the day for any follow-up questions. And we look forward to speaking with you at the various upcoming conferences and/or on our next quarter's earnings call. Thanks for your time.

[Operator]

This concludes today's call. You may now disconnect.