Toll Brothers Inc

NYSE:TOL

Earnings Call Analysis

Strong Q3 Results Prompt Raised Full-Year Guidance

In a record-setting third quarter, home sales revenues exceeded expectations at $2.7 billion, with 2,524 homes delivered, a 5% increase year-over-year. Margins improved due to cost controls and high demand, with earnings per share at $3.73. New contracts also surged by 77% in units, and the company raised home prices by an average of $20,000. Despite higher mortgage rates, demand remained robust. The strong backlog supports increased end-of-year projections, with earnings expected between $11.50 and $12 per diluted share and an estimated 22% return on beginning equity. The company is on track to deliver up to 9,600 homes at an average price up to $1.15 million, targeting revenues around $9.65 billion for the full year. Share repurchases and dividends will continue to be significant, aiming for $400 million in buybacks for the fiscal year.

Robust Financial Performance with Increased Guidance

The company delivered a stellar third quarter, surpassing their own expectations across several metrics including home sales revenues, adjusted gross margins, as well as administrative and general expenses (SG&A) margins. Consequently, the company has confidently raised its full-year guidance, with projected earnings per share lying impressively between $11.50 and $12. Furthermore, they anticipate a remarkable return on beginning equity of roughly 22%.

Record-Breaking Earnings and Home Sales Revenues

Highlighting the third quarter's record-breaking achievements, the company delivered 2,524 homes at an average price of over a billion dollars, resulting in extraordinary home sales revenues of $2.7 billion. Such success continued to the earnings per share, hitting $3.73—a third-quarter record for the company.

Pricing and Demand Across Regional Markets

Demand remained robust in both product lines and geography during the quarter, managing to push average prices up by $20,000. This financial feat was particularly pronounced in the Mountain and South regions, where average prices are generally lower, underscoring the strong market demand the company harnesses.

Backlog Signals Strong Future Revenue

The company's backlog stands strong at $7.9 billion with 7,295 homes awaiting completion. A noteworthy low cancellation rate of 3.2%, a decrease from the previous quarter, exemplifies the firm's customer base stability, with a significant portion paying in cash and most taking mortgages with substantial down payments. These factors suggest continued revenue potential in the upcoming periods.

Strategic Land Holdings and Share Repurchase Plan

With 70,200 lots owned or controlled, the company is carefully managing its resources, indicating a year-over-year reduction by approximately 15%. This demonstrates a strategic and disciplined approach to land acquisitions, aiming to bolster return on equity and capital efficiency. Additionally, an aggressive share repurchase plan for fiscal 2023 amounting to $400 million solidifies their shareholder return commitment.

Gross Margin Improvement and Efficient Operations

The company's adjusted gross margin has improved from the prior year, rising to 29.3%, while SG&A expenses have decreased both percentage-wise relative to home sales revenues and in dollar terms. This underscores the company's ongoing focus on cost controls and efficiency. Looking ahead, the company hopes to maintain the improved gross margin and decrease SG&A expenses as a percentage of home sales revenues.

Market Positioning and Future Outlook

Contracts signed in the quarter slightly dipped in average price but this was offset by pricing strategy adjustments such as increases and reduced incentives. The projected full-year adjusted gross margin saw an upward revision from 27.8% to 28.5%, also forecasted for the fourth quarter. Planned stock buybacks, growth in book value to approximately $65 per share, and cash flow generation exceeding $1 billion illustrate a confident outlook for the company's enduring financial health and shareholder value proposition.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, and welcome to the Toll Brothers Third Quarter Fiscal Year 2023 Conference Call. [Operator Instructions] The company is planning to end the call at 9:30 when the market opens. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Douglas Yearley, CEO. Please go ahead.

[Douglas Yearley, Chairman and CEO]

Thank you, Betsy. Good morning. Welcome, and thank you all for joining us. Before I begin, I ask you to read our statement on forward-looking information in our earnings release of last night and on our website. I caution you that many statements on this call are forward-looking based on assumptions about the economy, world events, housing and financial markets, interest rates, the availability of labor and materials inflation and many other factors beyond our control that could significantly affect future results.

With me today are Martin Connor, Chief Financial Officer; Rob Parahus, President and Chief Operating Officer; Fred Cooper, Senior VP of Finance and Investor Relations; Wendy Marlett, Chief Marketing Officer; and Gregg Ziegler, Senior VP and Treasurer.

We had another terrific quarter and are very pleased with our fiscal third quarter results. We beat our guidance for home sales revenues, adjusted gross margin, SG&A margin and earnings. Our quarter end backlog of 7,295 homes and $7.9 billion is strong, and our cancellations remain very low.

The market for new homes is solid, and we are well positioned with the right strategy in place to take advantage of it. As a result, we are raising our full year guidance for all of our core homebuilding metrics, including deliveries, adjusted gross margin and SG&A margin. We now project earnings of between $11.50 and $12 per diluted share in fiscal 2023 and a return on beginning equity of approximately 22%.

In the quarter, we delivered 2,524 homes at an average price of $1.06 billion, leading to record third quarter home sales revenues of $2.7 billion. Adjusted gross margin was 29.3% or 140 basis points above last year's third quarter, and our SG&A expense was 8.6% of home sales revenues 170 basis points better than last year.

Our margins continue to benefit from cost controls and greater leverage from higher revenues. With a significant beat on our top line and improved margin performance, we delivered earnings per share of $3.73, a third quarter record. We signed 2,245 net contracts for $2.2 billion in our third quarter, up 77% in units and 30% in dollars compared to last year's third quarter when mortgage rates were much lower in the 5% to 6% range.

On a per community basis, we sold at a pace of 2.2 homes per month compared to 1.3 last year and 2.3 last quarter. Demand was stronger than normal in our third quarter compared to the second, with contracts down only 4% sequentially versus the long-term average of down 15%.

Remember, the second quarter is historically stronger than the third since it is in the heart of the spring selling season. So running almost flat Q3 to Q2 is very encouraging, particularly with rates higher in Q3 than Q2.

Demand was also solid across both geography and product lines in our third quarter and we raised price by an average of $20,000. We saw particular strength in the Mountain and South regions where we tend to have lower average prices. Due to the shift in mix and notwithstanding the price increase, our average sales price was flat compared to the second quarter.

In terms of cadence, we saw a relatively steady number of deposits and contracts each month of the third quarter. Actually, June was our strongest month when normally, July is strongest. Often, that is influenced by a sales event. And this year, we ran a national sales event in June rather than July.

As we start our fourth quarter, demand remains solid. August deposits are usually down 25% to 30% versus July based on long-term historical trends as summer winds down and kids returned to school. So far in August, deposits are only down 11% and both physical and web traffic is up slightly compared to July. While it is only three weeks, this is encouraging considering the increase in mortgage rates that has occurred during this period

We attribute the solid demand for new homes, at least in part to the well-publicized shortage of existing homes for sale. Existing homeowners are clearly reluctant to give up their low-rate mortgages. And while rising rates remain a challenge for the overall industry, they further cement the lock-in effect that is kept to resell inventory at historically low levels. This has become a tailwind for homebuilders and especially the larger well-capitalized builders who build at lower costs and are better positioned to take advantage of spec building and buying down mortgage rates.

The supply/demand imbalance created by low resale inventory, compounds the impact of the persistent underbuilding of homes over the past 15 years. Even before resale inventory dropped, there was a structural shortage of anywhere between 3 million and 6 million homes in this country. In addition, demographic and migration trends continue to provide long-term support for the industry with millennials forming families and buying their first home later in life when they have higher incomes and accumulated wealth.

AB boomers who are either retiring or planning for it are also moving as they adjust to their new lifestyles. There also appears to be an increase in generational well transfer with parents helping their kids buy homes. All of these factors combined have kept demand for new homes solid in the face of higher rates, and we are benefiting.

Our strategy of increasing our supply of spec homes, which we implemented several quarters ago, has helped us meet demand while also helping to improve our cycle times. Our spec homes represented approximately 40% of our orders in the third quarter and we expect that to continue in the near term.

Specs were 28% of deliveries in the third quarter. We define a spec as any home without a buyer that has a foundation poured. We sell our specs at various stages of construction with a preference to sell before we finish the homes as many of our buyers want to personalize their homes. In this way, our buyers are able to select their fixtures, appliances, flooring and other finishing options while we benefit from a faster and more efficient construction schedule.

At third quarter end, our backlog stood at $7.9 billion and 7,295 homes. Our cancellation rate as a percentage of backlog was 3.2% in the third quarter, down from 3.9% in the second quarter. Our industry low cancellation rate is due to significant upfront down payments our buyers make as well as the emotional attachment they form as they personalize their homes with us.

Our buyers also tend to be more affluent. In the third quarter, 25% of our buyers paid all cash, up from 23% in the second quarter and our long-term average of 20%. Buyers who do take a mortgage make higher down payments with an average LTV of 68% in this past quarter.

We are also seeing modest improvements in our cycle times of supply chains and labor constraints continue to ease and as we increase production of spec homes. We expect cycle times to continue to improve as we move forward, which should further benefit our already strong cash flows.

Turning to land. At the end of our fiscal third quarter, we owned or controlled 70,200 lots, half of which were controlled and the other half owned. Excluding the 7,295 lots committed to home buyers in our backlog, our controlled land represents 56% of total loss.

Our lot count is down nearly 15% year-over-year, which reflects our selective approach to buying land and our focus on ROE and capital efficiency. Still, this land position provides us with sufficient land needed for growth in fiscal year 2024 and beyond and allows us to continue being selective and disciplined in our approach to buying land.

Since the start of the third quarter, we repurchased $163 million of our common stock bringing our year-to-date repurchase to $265 million at an average price of $68. We have also paid $69 million in dividends year-to-date. We expect buybacks and dividends to remain an important part of our capital allocation priorities well into the future.

As a reminder, we have planned for $400 million of share repurchases in fiscal 2023. Assuming we buy back an additional $144 million at the current price in the fourth quarter, which would get us to the $400 million for the year, we will have bought back about 5% of our diluted share count at the beginning of the year.

With that, I'll turn it over to Marty.

[Martin Connor, CFO]

Thanks, Doug.

It was a great quarter. We grew earnings per share by 59% and net income by 52% over last year. Homebuilding revenue of $2.7 billion was a third quarter record and increased 19% compared to one year ago. We delivered 2,524 homes in the quarter, up 5% year-over-year.

With the outperformance in the third quarter, we are raising our full year deliveries guidance. We now expect to deliver between 9,500 and 9,600 homes, an increase of approximately 200 homes at the midpoint of our previous guidance. We are also increasing our guidance for full year average delivered price to between $1.05 million and $1.15 million. This translates to a homebuilding revenue projection of approximately $9.65 billion at the midpoint for the full year. We signed 2,245 net contracts in the third quarter for $2.2 billion, up 77% in dollars and 30% in units over last year.

The average price of contracts signed in the quarter was approximately $964,000, which was down 1.1% compared to our second quarter average price of $975,000. As Doug noted, we actually raised price by an average of $20,000 in the third quarter through base price increases and reduced incentives; which was offset by changes in mix. Turning back to the P&L. Pretax income was $553 million compared to $366 million in the third quarter of fiscal 2022. Net income was $414.8 million or $3.73 per share diluted compared to $273.5 million and $2.35 per share diluted one year ago.

Our third quarter adjusted gross margin was 29.3%, compared to 27.9% in the third quarter of 2022 and 160 basis points better than projected. The improvement was due primarily to better cost control and fixed cost leverage on higher-than-expected home sales revenues. We are raising our full year adjusted gross margin guidance from 27.8% to 28.5%. This 28.5% is also what we expect in our fourth quarter. Note that our fourth quarter gross margin guidance includes the impact of homes that we sold a year ago in a softer sales environment.

SG&A as a percentage of revenue was 8.6% in the third quarter compared to 10.3% in the third quarter of last year. And this is 170 basis points better than projected. In dollar terms, our SG&A expense was $4 million lower this quarter compared to the third quarter of fiscal year '22 despite over $400 million of additional home sales revenue and the impact of inflation. As we've pointed out before, we've been very focused on becoming more efficient, and we are now seeing the benefits flow through our results. We are projecting full year SG&A costs to be approximately 9.4% of home sales revenues, which represents a 60 basis point improvement from our prior guidance.

For the fourth quarter of fiscal year 2023, we expect SG&A to be approximately 8.8% of home sales revenue. Third quarter JV, land sales and other income was $39.4 million in the quarter or $14.4 million above our guidance. We now expect our full year joint venture land sales and other income to be approximately $105 million, down from the $125 million previously projected. This is due primarily to a challenged market for apartment building asset sales. Our new guidance assumes we closed the sale of three stabilized apartment communities that we expect to sell in this fourth quarter.

Our tax rate in the third quarter was 25%, 100 basis points better than our guidance. We expect our fourth quarter tax rate to be 26%, which would bring the full year rate to approximately 25.4%. We expect interest in cost of sales to be approximately 1.5% in the fourth quarter and for the full year as we continue to benefit from our reduced leverage. We expect community count to be approximately 375 by fiscal year-end with continued growth in fiscal year 2024. Our weighted average share count is expected to be approximately $111 million for the full year and $109.5 million for the fourth quarter.

We reiterate our guidance for approximately $400 million of share repurchase year, implying approximately $150 million of buybacks in the fourth quarter. Putting this all together, we expect to earn between $11.50 and $12 per share in fiscal year 2023. We expect to achieve a full year return on beginning equity of approximately 22%, and we expect to bring our book value to approximately $65 per share at year-end. This would be the second year in a row, we earned well over $1 billion, and this is in a period when mortgage rates doubled from slightly over 3% in November of 2021 and to their current level, around 7.5%. In addition, since 2020, we have generated an average of $1.1 billion of operating cash flow per year and we expect 2023 to also exceed $1 billion.

Turning to the balance sheet. We finished the quarter with a net debt-to-capital ratio of 20.5%, $1 billion in cash and cash equivalents and $1.8 billion available under our $1.9 billion revolving bank credit facility providing us with ample flexibility to both grow our business and return capital to stockholders.

We also have no significant bank or senior debt maturities due until November 2025, which is fiscal year '26 for us. In recognition of our financial position, the solid demand for new homes and strong fundamentals underpinning the market as well as our favorable long-term prospects, Standard & Poor's upgraded our credit ratings to investment grade this quarter. We are now rated investment grade by all three major credit rating agencies.

Now let me turn it back to Doug.

[Douglas Yearley, Chairman and CEO]

Thanks, Marty.

Before I open it up for questions, I'd like to recognize the hard work and dedication of all of our great Toll Brothers employees. It is your passion for our business and commitment to our customers that will ensure our continued success.

Betsy, let's open it up for questions.

[Operator]

[Operator Instructions] As a reminder, the company is planning to end the call at 9:30 when the market open. [Operator Instructions] The first question today comes from Rafe Jadrosich of Bank of America. Please go ahead.

[Rafe Jadrosich, Bank of America]

Hi. Good morning. Thanks for taking my question.

[Douglas Yearley, Chairman and CEO]

Good morning, Rafe.

[Martin Connor, CFO]

Good morning, Rafe.

[Rafe Jadrosich, Bank of America]

Doug, I wanted to follow-up on a comment you made earlier on the gross margin. You're seeing the fourth quarter outlook for 28.5% includes the impact of homes that were sold last year in a softer sales environment. How do we - you have more visibility than other builders on the gross margin outlook. How do we think about how that goes going forward, just given that we saw at the beginning of the year, the sales environment that definitely improved?

[Douglas Yearley, Chairman and CEO]

Sure. So, we'll give full guidance in December as we always do for 2024. And so, we're not going to get ahead of ourselves right now. Marty's comment and our guidance, which is about 80 basis points lower than the 29.3% gross margin we achieved in Q3, for a 28.5% in Q4 was just a reminder that if you go back 12 to 15 months, the market had slowed dramatically.

That's why we mentioned remember, back in April of '22 is when rates went up dramatically, and late spring of '22 through the summer and fall, the market softened dramatically, we reminded everyone back then that we were not going to chase the bottom and we didn't. And so on 80 basis point drop is pretty well range-bound when you think about Q4 is going to represent a bit more of the sales that occurred back in that period of time.

But it's - again, it's only 80 basis points. Some of the sales from that slower time will continue into the beginning of '24. But we're not going to get into the specific guidance until December on where - the first quarter of '24, and the balance of the year comes out. But there is some shorter-term pressure, but the pressure is modest, because we did not chase the bottom.

Some of the other builders, as you know, had a pretty dramatic drop in margin for the sales that came through that period of time. And as you can see, based on our guide for the next quarter, our impact is very minimal.

[Rafe Jadrosich, Bank of America]

Thank you. That's very helpful. And then just we've seen an improvement on the backlog conversion over the last few quarters here. How do we think about additional opportunity going forward? Where are you versus your kind of historical average? And how do we think that could play out over the next few quarters?

[Martin Connor, CFO]

Well, Rafe, I think we expect to see better backlog conversion, because of reduced cycle times on the to be built as we are in a more stable supply chain environment, we've addressed some reductions in SKUs, and we're getting better at building the to be built. But the big piece is going to come from more specs. Specs this quarter were 28% of deliveries.

We're targeting 40% of sales. We achieved that this quarter. And so, they'll be 40% of deliveries and they'll have a little bit less time in backlog, a lot less time in backlog than a to be built.

[Operator]

The next question comes from Michael Rio with JPMorgan. Please go ahead.

[Unidentified Analyst]

Hi guys. Thanks for taking my questions. This is Andrew [indiscernible] on for Mike. I just wanted to get a sense of kind of regionally, market-by-market where you're seeing that ability to push price a little bit better, and where it's a little bit more summer? Thanks.

[Douglas Yearley, Chairman and CEO]

Sure. So really pleased nationwide. And by the way, the $20,000 price increase we saw in Q3, I know the question will come up, it's about a $10,000 drop in incentive plus a $10,000 increase in the base price or the sales sheet price. The incentive was about $55,000 in Q2 when it went to $45,000 in Q3, and then the price went up by 10%. That's on average.

And it's not everywhere, some areas or more. We still have some locations where we've gone to - we're still doing final and best seal bid on select communities or select inventory. The best markets, and we mentioned the Mountain and the South had done the best, this past quarter. Denver, very strong. Boise, Idaho is back in a big way after taking a pause. Southern California, very strong.

Atlanta, New Jersey and Pennsylvania, very strong, and then all of Florida, a bit softer where we're still feeling a little bit of pain. Phoenix hasn't come back yet. It's better, but it hasn't come back as we look forward to it coming back at some point, but not yet. And then on that list, I'd also throw in Portland, Oregon, which is a very small market for us. But that has been a bit softer.

[Unidentified Analyst]

Thank you for that granularity. I appreciate it. I guess I wanted to ask about the sustainability. Obviously, this was a very nice SG&A. Maybe if you can bucket out what was driving that and kind of the sustainability going forward?

[Douglas Yearley, Chairman and CEO]

Sure. So, we talked now for over a year about a commitment and a drive to make Toll Brothers more efficient. And we're not done. But our headcount is down 11%, and our business is growing. And there's also lower inside and outside commissions being paid on the sales side, but it is primarily overhead. And we will continue to look for opportunities to do more with less. I'm super proud of the steps we've taken. It will continue. And those are the main drivers of it.

[Operator]

The next question comes from Stephen Kim with Evercore ISI. Please go ahead.

[Stephen Kim, Evercore ISI]

Yes. Thanks very much guys. Obviously, great results. Thanks for all your comments so far. I do think it might be worth sort of thinking about what might happen if you were to see a slowdown in demand, I appreciate that in August, you - what you shared with us certainly suggests you haven't seen that much of a negative impact from higher rates. But I think it also fair to say, we don't really know what's going to happen with rates in the next few months. And so, hypothetically if you did see buyer demand slow. Do you look back upon strategy that you pursued last year where you let - orders slow significantly rather than get aggressive with incentives? Do you look back on that and say, this is - that we were vindicated that that was the right thing to do. And if demand slows in the months ahead. You are going to do - we should expect you to do a very similar thing that you did last year with respect to letting your order slow, but holding the line on price?

[Douglas Yearley, Chairman and CEO]

Yes. I am very proud of this management teams, it's very thoughtful decisions around our strategy to not chase the bottom. I think we ramped up our specs strategy at the right time. And building costs were beginning to coming down, supply chain was easing. And so yes, we are not - we are a margin focused builder with an understanding of course that capital efficiency, ROE finally at the right way.

It's critically important long-term success, but our houses are big. They're complicated. They have a lot of upgrades, and features and they take a while to build, and we're not giving them away. We're not going to chase the bottom. It doesn't mean we're going to have our head in the sand and not have more incentives in a soft market than we had in a good market.

I mean that's part of the conversation we've had around this modest drop in margin next quarter. But yes, I think the strategy has worked, and we will continue with that strategy if your hypothetical was to prove true.

[Stephen Kim, Evercore ISI]

Excellent. Thanks so much for that. It was very clear. And then taking it a step further, can we talk a little bit more about our capital allocation, again, under this hypothetical scenario, which hopefully doesn't actually manifest. If we do enter a softer demand patch, you've been pretty good with capital allocation in terms of dividends, and buybacks and so forth. Would you likely though, shift even more capital to buybacks as opposed to investing in land, particularly since you have a lot more cash actually than you did last year? And more broadly, with emerging long-only interest in the space, do you feel maybe the time is right to pursue, a more asset-light strategy that might bring your year supply of owned land down to like two years or less, as we think about the longer-term positioning of the company strategy?

[Douglas Yearley, Chairman and CEO]

Yes. Our next debt maturity, as Marty said, is November of 2025 which is fiscal '26. We've been generating more than $1 billion of free cash flow for the last several years, three or four years. We have dropped our lot count by 15%, still being able with a lot - land we control to grow community count last year, this year, next year and beyond. Our land teams are very good at structuring land deals, to be more capital efficient.

We're doing joint ventures. We're relying upon land bankers. We're getting purchase money mortgages from land sellers. We're buying improved lots just in time. Can we get it down to two years owned, that's hard to do when you control main in Maine. That's all I'll say. We're moving in the direction of having less owned land, but I'm not going to agree that two years is possible only because our business model, where we buy land is a bit different.

Our land is very special. It's very unique and not every deal lines up with somebody there to feed you finished lots at the corner main in Maine in Greenwich, Connecticut, Princeton, New Jersey, Irvine, California...

[Martin Connor, CFO]

Radnor, Pennsylvania.

[Douglas Yearley, Chairman and CEO]

Radnor, Pennsylvania - take it home. But we are moving in that direction, and you will continue to see that effort as we go forward.

[Operator]

The next question comes from Joe Ahlersmeyer with Deutsche Bank. Please go ahead.

[Joe Ahlersmeyer, Deutsche Bank]

Hi. Good morning, everybody. Congrats on the results.

[Douglas Yearley, Chairman and CEO]

Thanks Joe.

[Joe Ahlersmeyer, Deutsche Bank]

I wanted to dig in on that point you made earlier, about the higher down payments, lower loan to values. If you could maybe just hit on the psychology of this, whether you feel like your buyers are different in this regard. Meaning again, for those three out of four that are taking a mortgage, a 20% down payment, maybe a certain monthly payment, but are we sort of infer - to infer that even with rates at higher levels, there is sort of cash on the buyer's balance sheet, that they're using to knowingly pull forward that cash outlay, and just reduce their overall debt service?

[Douglas Yearley, Chairman and CEO]

Joe, for sure. And to put it - I know I said it, but I'll remind everybody, long-term, 20% of our clients were all cash. This quarter was 25%. And there's a good reason for it. I have the money. I'm wealthy, and I don't love a 7.5% rate. So, I'll put more of my own money to work and less of the bank's money to work. Our LTV has gone from 70%, it is for those that do get a mortgage to 68%, same reason. I'm going to put a little bit more down.

Our buyers are clearly wealthier. They have equity in their homes. Remember, the resale market is very interesting, but good, solid used homes. Sorry, we like that term as new homebuilders. They sell, and they're selling quickly, and they're selling, in many cases, above asking price. What is sitting on the market is the old tired inventory which actually makes it even better for us, because not only is the resale market really tight.

But the quality of what's sitting on the resale market is lousy. We hope our buyers have some of the better homes that are moving faster. And therefore, they may be getting a bit more equity out of their home than they had thought. So they're wealthier. They're getting a bit more equity out of the existing home, and they want to move. I talked about it on the last call, find a house for people besides Marty Connor, our CFO, is not a strict financial decision, it's a family decision. It's emotional. It's moving all of your life.

It's getting the kids in the better school. It's moving down as an empty nester. It's buying the second home. And all of that wins, it trumps the straight financial calculation on the back of a napkin, and where do they go? They may start on a resale market. They can't find anything. We're really proud of what we do. We're really good at what we do. We have groupies. People want and aspire to get into the Toll Brothers house.

We sell 10,000 a year, hope to sell 12,000, then 14,000 then 16,000, but in the scheme of the 1 million-plus houses, new homes that are sold in this country in a year. We are a small fraction of it, and there are plenty of buyers still out there, that are in the market even at 7.5%. And we're benefiting from that, and that's going to continue as our brand gets better and better.

[Joe Ahlersmeyer, Deutsche Bank]

Yes, it makes a ton of sense. I'm glad you sort of took it that direction, because I think a lot of times, folks are hearing the word tailwind, and maybe understanding it, at least on the existing home inventory point to mean future headwind, right? And I'm just curious if you see it this way. It sounds like you don't - I don't want to put words in your mouth, but maybe if you could just in your answer sort of touch on what you see as the most likely scenario for existing home inventory rising, and whether - or not you think for Toll, this actually would represent sort of a follow-on tailwind. Because it means more of your prospective buyers are shaken loose from those existing homes? Thanks.

[Douglas Yearley, Chairman and CEO]

Yes. I'm not suggesting that a 7.5% market is good for the industry. It has proven to be good for the new homebuilders, because the wider the spread between mortgage of the existing homeowner, and today's new rate, the more lock-in effect is occurring. So, the resale market is tighter in a 7.5% rate environment than it was in 6.5%.

Because there's more people that are locking in. But all day long, I will take a 5.25% rate market that frees up more existing homeowners to want to move up into our homes. Of course, I'll take that. And will there be a bit more competition on the resale market, because it is freeing up, yes. But there will be many more of those of those - homeowners that want to move up where overall, we will benefit and have even better results.

We're just very pleased with how well we're doing, considering how fast the rates have gone up, how they continue to go up, and our traffic is good, our web traffic is good. And our sales are good, and it's primarily driven by what I said. There are still buyers out there. They have very few options. They therefore find their way to us and they fall in love as we knew they would.

[Operator]

The next question comes from Mike Dahl with RBC Capital Markets. Please go ahead.

[Mike Dahl, RBC Capital Markets]

Good morning. Thanks for taking my questions. Doug, just a follow-up on kind of the LTV cash buyer dynamic. One of the interesting things about this recent rise in rates as I think - at various points over the last year, the conventional 30-year had gone above 7%, but you look at arms or jumbos or FHA VA and they had kind of lived more in the like 6%, 6.5% range. Now all rates have kind of surpassed 7%, the spreads have all compressed. Can you just talk a little about - have you seen that like as people are putting that little extra money down, are you seeing people shift out of out of jumbos into conventionals, or any shifts and own products? And part two is, given there's not as much hypothetical arm between jumping around products today. Have you started to lean back into your buy downs over the last month as rates have risen?

[Martin Connor, CFO]

Mike, I'll take a shot at the first half of that in terms of what we have seen buyers do. Often when rates rise, we would see them gravitate to adjustable rates. And we haven't seen that, because it hasn't been attractive. The spread between adjustable and fixed just has not been substantial enough to motivate somebody to go in that direction. We also just came through a period where jumbos were less expensive than conventionals. And so in '20, '21, '22, we saw buyers borrow more so that you could get to the lower jumbo rate. Right now, we're seeing the inverse of that. We are seeing them increase their down payments and reduce what they're borrowing so they can stay in conventional to a greater extent.

[Douglas Yearley, Chairman and CEO]

With respect to buy downs and whether we've accelerated that lately, the answer is no. The buydown program doesn't work for the build-to-order business because you can't buy down a rate that's 12, 14 months out. But it does work well as a lead marketing headline for the spec inventory that can deliver over a four-month period of time. So we may advertise for spec inventory that will take a 7.5% rate down to 5.5%.

But the cost of that, and let's just say it's maybe $40,000 or $45,000 on the $1 million home the total sales, it doesn't capture the buyer's attention as much as them deciding or can I use that 445,000 and by finishes in the house or do something that is long term.

And I think the reason for that is they don't look at the 7.5% rate of the 30-year rate they're stuck with. They look at it as a shorter-term time frame where they're going to refi out of it when the rate comes down. And so why use my incentive to buy a rate down that I'm not going to have for a long period of time. That doesn't mean some don't take advantage of the buy down, but it's not like all of our spec inventory is being sold through the buy-down program, and that's where all the incentive is going. It's a marketing headline. It grabs attention. It starts conversation. Some take it, but more flip the dollar value of the buy down into upgrades or features within the home.

[Mike Dahl, RBC Capital Markets]

Yes, that's interesting. Thanks. And maybe that's also a point of differentiation for your wealthier buyer. The second question is...

[Douglas Yearley, Chairman and CEO]

Right, because it's not a straight affordability issue where they have to have the 4.5% rate to get approved, it's more discretionary as to where do they want to spend the incentive.

[Mike Dahl, RBC Capital Markets]

Yes, yes, yes. Okay. Second question, and maybe, Marty, this is just a technicality or a clarification on the earnings guide, $11.50 at the low end. If I bridge your operating metrics and account for the year-to-date charges, I think you'd get to a number that's still maybe $0.30 give or take, north of that. So is that really just hedging for - you're saying your guys including the three buildings that you anticipate to close is as simple as you're hedging in case those don't close in the fourth quarter? Or is there something else in the core operating metrics where you think there could be some give or take.

[Martin Connor, CFO]

Well, I think we're trying to get to some rounded numbers, $11.50 to $12, is pretty rounded. I think there's some caution in there if something doesn't go according to plan. We don't project any impairments. We don't expect any, but there may be some. And so it's as simple as that, Mike. I don't think - I think you're reading much more into it than you should.

[Mike Dahl, RBC Capital Markets]

That's helpful. Thanks.

[Douglas Yearley, Chairman and CEO]

You're welcome.

[Operator]

The next question comes from Ken Zener with Seaport Research. Please go ahead.

[Ken Zener, Seaport Research]

Good morning, everybody.

[Douglas Yearley, Chairman and CEO]

Good morning, Ken. How're you?

[Ken Zener, Seaport Research]

I'm doing well. Appreciate all your comments. I wonder if you could quantify - you've mentioned base pricing. Could you give us a sense this quarter, last quarter versus a longer-term trend. What's your kind of base price and how much of options traditionally been a percent of your sales. And the reason I'm asking that is, obviously, with this liquidity from your buyers, options historically have a higher margin profile. So I'm trying to sense if you're seeing greater share of options and what the impact is historically on your gross margins? If you could give us some context. Is that my first question.

[Douglas Yearley, Chairman and CEO]

Sure. Long-term average upgrades, and that includes the lot premium, right. It's 21%. Q3, it was 27%, $236,000. That's counterintuitive, right, with rates going up, do you think maybe people are moving towards smaller homes, more affordable homes, not the case. And that goes right to the wealth of our clients and how we do it. This is their dream move. And if they can afford it, they're going to reach. And so I'm not telling you that trend is going to continue.

I don't know, but those are the numbers. 21% long-term average upgrades, Q3 27%. And yes, the margin coming out of our design studios where we send the client to pick all their beautiful finishes is higher than the company's gross margin.

[Martin Connor, CFO]

And the lot premium is 100% gross margin.

[Douglas Yearley, Chairman and CEO]

And the lot premium is...

[Ken Zener, Seaport Research]

Correct. What is the - well, I guess, following up on that, what is the split between land and the physical upgrades, if you would? And then the second question I really want to address is you talked about 2,200 presale units last quarter. I don't know if you guys are updating us on inventory units yet. That would be useful. But could you maybe talk about where we are in terms of those presales starts as well as that land upgrade mix, if you could. Thank you.

[Martin Connor, CFO]

Greg. So I think we have approximately 2,400 specs under construction compared to the 2,200 you mentioned, and we have around 400 at CO or beyond compared to 350 last quarter last quarter. In terms of a breakdown of the option premium versus things in the house - what have we got there? You say in...

[Douglas Yearley, Chairman and CEO]

Yes, Ken. So the base house prices for the quarter was call it, high $870,000. So the lot premium this quarter, again, at 100% gross margin was almost $60,000 and then the option upgrades were around 175,000. Now that will include both the design studio and structural options.

[Ken Zener, Seaport Research]

Thanks.

[Operator]

The next question comes from Alex Barron with Housing Research Center. Please go ahead.

[Alex Barron, Housing Research Center]

Yes. Thanks, everybody. I was hoping we could focus a little bit on your ASP trends, especially in orders. I'm guessing, July quarter a year ago was a bit distorted maybe by cancellations? Maybe not. Maybe you can clarify that. But clearly, the trend has gone from the $1.1 million towards $960,000. I'm just trying to understand that better. Is that due to more specs that are lower priced? Are you guys building smaller homes? Is it a more intentional thing that's going to continue? Or do you feel like the prices are here to stay at that level of the orders this quarter. Just some better understanding would be helpful.

[Martin Connor, CFO]

It's really a function of mix, Alex. I think we talked about the success we've had in the Mountain region and in the South where our prices are generally lower than they are in California or in the North. And so as the business has shifted to those geographies and as we've increased the affordable luxury line as a percentage of total, the average price mathematically comes down. It is not a function of building house type A, this year at 4,000 square feet and last year, it was 4,200 square feet. It's really just a function of the mix shift from a geography perspective as well as a market segment perspective.

[Alex Barron, Housing Research Center]

Okay. So all else being equal, you don't necessarily see these trends taking the price further down necessarily or possibly yes.

[Douglas Yearley, Chairman and CEO]

I think they could modestly go lower. But again, it can be very lumpy quarter-to-quarter based on what is delivering. We are now north of 40% affordable luxury. And I think we've said we're kind of - we're comfortable with affordable luxury getting as high as half of our business. And we also have to be careful how we define affordable luxury now because it is - it's gone up fairly dramatically in price through the COVID years and it's a very gray area.

We don't market it to the public as affordable luxury. It's just an internal term to help us with how we prepare for marketing, how fancy we decorate the model homes and build the entrance features and also, I think it helps the Street in understanding this move we made in price. But we're close to where I think we want to be long term in terms of the mix between the affordable luxury, the true luxury the empty nester move down, et cetera. So there could be some modest drop in price, but I think you've seen most of it already.

[Operator]

The next question comes from John Lovallo with UBS. Please go ahead.

[John Lovallo, UBS]

Good morning, guys. Thanks for taking my question. I guess the first one is, that seasonality has certainly been a little bit tricky over the past few quarters, and you guys did better-than-normal seasonality in the most recent quarter. Just curious how you're thinking about absorption as we move into the fourth quarter, given what you're seeing out there in the market today.

[Douglas Yearley, Chairman and CEO]

Yes. It feels right now, John, like it's trending very similar to Q3. And I think our comments around the three weeks of August helped explain that. We're running at a pace right now of about 24 homes sold per year per community. Last year was 25 homes sold per year per community. So it's relatively flat, and that's what we're projecting. The 2010 to 2019 time frame, again, pre-COVID, we tracked at about 22 sales per community per year. So we're modestly call it, 10% or so above that. But that's what we anticipate for the fourth quarter.

[John Lovallo, UBS]

Okay. That's helpful. And then you guys mentioned cycle times improving. Just wondering if you could help us kind of quantify where they are today maybe versus last quarter, maybe pre-COVID. And then how much of that improvement is getting better on the to-be-built side versus just offering more spec?

[Douglas Yearley, Chairman and CEO]

Cycle times are coming down slowly. We're picking up a couple of weeks. For the next home sold a range is about 10 to 11 months. I think the exact number, I think, is 315 days is what we project when you average out the entire company. That's obviously down dramatically from the COVID years and it's similar to what we saw pre-COVID.

But we are more efficient. There's no question. We changed our operating model in the field. and we're enjoying those efficiencies. The spec build as a larger percentage of our business is certainly helping because we can get to how started without the customer making all the selections. We can build the house without the customer visiting every Sunday afternoon and coming back at us with their own little punch list and how those are less complicated because we're not loading them up as much as some of our clients do when they run through the design studio. So that is certainly helping.

We have less SKUs. We have optimized all of our plans. We have less homes that we offer, and all of that is contributing. And I do feel like it's just the beginning, particularly with almost half our business being affordable luxury, which means smaller, simpler homes and this operations focus on becoming a better production builder there's still room to go. But I am encouraged that we're down a few weeks, and it's trending in an even better direction.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Douglas Yearley, Chairman and CEO]

Thank you, Betsy. Thank you, everyone. We appreciate all your great questions and all of your interest. We're always here. As you know, to answer any additional questions off-line. I hope everyone had a wonderful summer although I believe it's over. And we'll see you through the fall and back on a call in December. So thanks again. Take care.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.