Thank you, Phillippe and Hilla, for allowing me to be a part of this presentation today. For those of you that do not know me, I am Alan Ratner. I am the Home Building Analyst at Zelman & Associates. I've had the pleasure of covering Meritage Homes for almost 20 years now, and over the course of my career, the company has undergone several iterations of its you know sales strategy and operating strategy. I know when I first started covering the company, they probably were more in that asset light, 90%+ option, more of a move-up, higher-end builder, kind of single-market focused in Texas, Arizona. Obviously, they've expanded a ton over the last two decades and have pivoted towards more of an entry-level sales strategy.
So I'm excited to hear from Phillippe and Hilla about the next evolution of, of Meritage and, the three tenets, as Emily mentioned, of their, their, go-forward strategy. So with that, Phillippe, I'm going to hand it over to you, and I know you want to provide some, opening remarks, and then we can keep it interactive with some Q&A along the way. So please add your questions to the box, and I'll do my best to intertwine them along during the discussion.
Thanks, Alan. We are excited to find time to share our thoughts with everyone in this Investors Day Call series. Meritage has grown substantially since we implemented our last major strategy shift in 2016. We have gained market share and became a top five builder in the U.S. two years ago, all while producing some of the best-in-class metrics. Over the past five years, we have grown our deliveries 9% annually and our home closing revenue 11%. Our gross margin has expanded 590 bps from 2019 to 2023 to 24.8%. At the same time, our home closing gross profit increased 17%, our net earnings grew 24%, and book value per share expanded 20%. But this is just the starting point for us.
We want to continue to refine our strategy to allow us to grow our business and expand beyond our current state. That's what we are here to talk about today. We've invested in the people and technology for significant growth. We expect to be able to leverage everything we've put in place and the scale we've achieved at 15,000 unit as a 15,000-unit builder, to be able to become much larger. We'll cover this in more detail on our second call, but we've set our internal targets beyond a 10%-20% growth over the next couple of years. Now that we have our foundation built, we want to leverage it in a unique way to get us to the next level. So with that, let me introduce the evolution of our current business strategy.
We've been breadcrumbing this, these changes to our strategy over the past few quarters on our earnings call. Today, we want to cover in more detail the evolution of our entry-level spec strategy into its natural phase. Since late 2016, we have been migrating away from our second time move-up and semi-custom history into our EL, 1 MU focus, which is based on transparency in all that we do, streamlining our operations and our internal mantra of Easy Equals Right. This strategy was centered around several axioms: Shift focus to the largest population cohorts in the U.S., millennials and baby boomers, and more recently, Generation Z. All of these potential customers are looking for a similar product offering on an entry-level or 1 MU home. Sales pace targets of four to five net sales per month for EL and three to four net sales per month for 1 MU.
Pace over price until we hit our sales pace targets, when we also then go get price and push our gross margins. Over time, we move from 100% spec in EL with design collections for 1MU to a full spec strategy in both EL and 1MU, although we differentiate interior amenity levels. With that move, we closed down all of our design studios in 2023. With the spike in rates in early 2022, the resale market has been fairly locked up, and home builders as a whole have grown market share from a historical average of low teens of the total market to 30%-40% today. While we are more than taking our fair share of the current dynamics, we want to be able to continue to effectively compete with the largest resale market pool once the market comes back.
While we don't believe that will happen in the next quarter or two, we expect our new focus will help us outperform the market today and hold our volume of higher volumes once the new and used home market do restabilize. Thesis for new strategy focuses on why we should compete with resale. We want to have an access to a bigger piece of the total home building population in the U.S. We need to try to identify what causes a buyer to pick something used versus something new, when the pricing differential isn't huge. In similar industries, like cars, the goal is to buy new.
When buying a new car, customers place value on the warranty, not needing an extension, inspection, knowing that they are the first owner, and everything in the car is functioning properly, and the financing solutions offered by the dealer are available. All of these distinguishing factors elevate the desirability of the new versus used product. Looking at the home building industry, there are many parallels. We have all the same new product benefits, but there are also some objections from the customers. The first major objections, our homes aren't ready on the timeline that the customers want. That's tough for customers, tough to plan around moving, tough to think about how the change will impact them personally and include creditworthiness, potential financial exposure, if unable to move in the timeline that they would like.
It's also not ideal for the Realtor community, not a priority for them to list new homes, while used homes can meet customers on their timeline. New homes will lose customers to the home builder agents, and Realtors are not paid in a timely fashion. The customization process ends up more costly than anticipated. When buyers go through a customization process, they dream of the home that they think they're going to have, but it doesn't always come together the way they planned. They're not as good as we are in picking out the combinations that make the house beautiful. And it adds way more time to the building process, and then the home isn't perceived as move-in ready.
Sometimes when you buy a new home, you don't believe that you're going to have ceiling fans and blinds and landscaping and et cetera. So this has prevented customers to thinking about new homes in the same fashion they think about used homes. But our business strategy since 2016, we've eliminated those objections. We've provided move-in-ready inventory, where homes can meet you on your timeline, and we've provided homes that are turnkey. They have all the features that you would get in a used home market, and therefore, our customers can plan their lives and appropriately on their move. Our product and our processes align and remove those objections, and additionally, we provide opportunity to improve financial and operational metrics, and it's allowed us to grow substantially since 2016. We got there using our current operating strategies, and now we're thinking about what we need to do next.
We're thinking about three areas which can only help us compete with the resale market even better when it re-becomes relevant in the competitive set. The areas are as follow, and they were substantiated by extensive consumer research. We spoke to a certain number of customers and a number of Realtors and asked specifically, "What are the objections to buying new versus used when you remove the timeline, the difficulty of building, going through a customization process?" These were the three areas of opportunity. The first was having a 60-day guarantee. People believe that when they buy a used home, the home will close on the time that they expect. When you buy a new home, the belief is that you will close when the new home builder is ready to close, and you're not meeting the customer on their timeline.
So we are focused on building enough specs in all of our communities with enough choice and enough features, where a person and a couple or a family won't have to make that compromise. We will meet you on your timeline, and we will guarantee a 60-day move-in ready. The second objection we talked about was that new homes are perceived as not turnkey and ready to move in. When you go and look at existing home market, even though you're buying something that was used and lived in, you believe you're buying something that is ready to move in, right when you move in, and all you're moving in is in your furniture.
So we are focused on having turnkey-ready inventory, homes that have all the features that you expect when you buy a used home, but the choice is now just to buy new versus used. And then finally, a focus on building strong connection and, and relationships with our Realtors. Realtors drive the activity in the used home market because they believe all these things, too. They believe that they don't want to take their customer through a new home build process because it's complex, because we won't meet them on their timeline, because it's not turnkey, and because they won't get paid on time, and they won't be able to solve for the financing that their customer will need.
We're trying to remove those objections not only for our customer, but also remove those objections for our Realtor, and we're focusing and leaning in on the Realtor relationship because we, we believe that they drive a lot of behavior in their customers as it relates to buying new versus used. And then this feeds into our growth story. As we said, we've grown substantially from since 2016, from the 12th largest builder to now the fifth largest builder, and we're guiding to close to 14,750 units. This is scale that has allowed us to access the market in a different way, and it is very important to us to scale from here.
We believe by focusing on the resale market and competing directly with that segment of the market, focusing on those customers, focusing on the Realtor who drives that activity, we have the ability to scale from here and grow even beyond where we are at. Our goal isn't to be the best fifth largest home builder in America. Our goal isn't to be the best 14,000-15,000 unit builder in America. Our goal is to be the best builder in America. We now have the scale, we now have the strategy, we have people and technology and the operating, the operating system to scale from here, and we're focused on our next story. I'd like to thank everyone who joined this call so far today and for your continued interest in Meritage.
We'd like to open this up now for questions, for Q&A, and I'll pass it back over to Alan.
All right. Well, thank you, Phillippe, and thanks for running through that because I do think that perhaps there's a little bit of, you know, just lack of clarity to some extent around the differences in sales strategies that a lot of the public builders employ right now. And maybe we could kick off first with the first tenet that you outlined there, that 60-day guarantee, because I do think that that is certainly unique, and I think it makes a lot of sense relative to your largest competitor, which is the resale market. Without asking you what other builders do, I guess my question is, we've heard a lot about this spec shift strategy from a lot of builders of late. How is that 60-day guarantee different, perhaps, than you have operated in the past?
Meaning, you know, have you kind of adjusted your thought process on when is the ideal time to sell a spec home? And, you know, when you look across the broader market, is that something that's unique to Meritage compared to some of the other publics that are all talking about increasing spec share, but they don't really go into much detail about when these homes are actually coming to market and being transacted for?
Yeah, great question. I think it's a meaningful shift, not only from Meritage's perspective, because this is something new to what we've done, and I'll talk a little bit about that pivot here in a second, but I also believe that it's absolutely something that can be unique. I think most builders aren't willing to make that decision for a variety of reasons. Number one, when a customer comes into your community and is looking to move in 120 days versus 60 days, your natural action is to take that customer off the street. So now you're saying, "Well, you're not our customer until you're ready to move in 60 days," so that's a big shift. The second thing is that now, as a builder, you're carrying homes later into the cycle before you release them for sale.
We're always looking to turn our inventory as fast as we can, so that sort of feels like in conflict. Why would you not sell a home earlier versus waiting till later? And why would you make that intentional choice? So I believe most builders won't migrate to this aspect of the business, because now they're saying no to customers, and they don't wanna say no to customers. While we feel comfortable that although we're saying no to those customers, we're saying yes to a whole bunch of customers that currently aren't shopping for our product because they're in the existing home market, shopping for homes that they can move in in 60 days. So we're very committed to saying yes to the to that customer. As far as Meritage, you've seen it in the last two quarters.
The reason our backlog conversion rate now is above 100%: yes, there's a macro climate here that is unique with the used home market being locked up, but it is absolutely intentional that Meritage is now releasing homes on this 60-day window. And we're building more specs in all of our subdivisions. We're carrying more specs. We're staging them in a way where we have 60-day move-in-ready homes. Then, once those sell, we have the next batch coming up behind them and the next batch coming up behind them, and we're very production-oriented, so we never have a community that doesn't have 60-day move-in-ready inventory. So what are the implications of this financially? Well, here are the balance sheet implications. We're clearly carrying more specs than we've ever had before. You can look at our balance sheet metrics.
You can see the amount of homes we have in WIP, and you can see we're carrying that inventory because we're focused on this 60-day move-in. We're also carrying homes later into the cycle, which means we're paying incremental carry cost on those homes as we carry them into that 60-day window. If we would've went under contract in 90-day versus 60-day, the carrying cost might be less in that scenario. But what are the pros? The pros are we're converting a much faster rate of our backlog. You can see our backlog conversion is operating at a very high level. We're not ready to commit to exactly what it's going to be, but we know it's gonna be over 100% going forward. We're able to access the resale market in a different way.
We're able to have conversations with Realtors that have customers that they wouldn't have brought to us in the past, that they are willing to bring to us now because we have 60-day move-in product. So as the used home market starts to come back, and we're seeing that in certain markets, obviously, where the existing home market is starting to become more relevant, we have Realtors specifically bringing their customers to us because we can compete directly with that timeline. The other benefit is we're able to solve affordability in a different way. This is really, really important. When you have homes that people can move in within 60 days, you no longer need to do a rate lock. All you have to do is a rate buydown, because mortgages lock within 45 days of the close automatically.
That's the way the mortgage environment works. So buyers are absolutely willing to take that 15-day risk, knowing that their mortgage is gonna lock, and so then all our focus of our incentive dollars is really focused on the buydown, getting them into a payment that they can afford. So that's a benefit. And then the last one, and I think this is equally as important, although we're only two quarters into this, and nothing about today's housing market makes a ton of sense, so these things may change over time. We are convinced that we are gonna have a lower cancellation rate if we do this, because when people buy a home in a 60-day window, they're already out shopping for their furniture two weeks later because they're committed, and they're moving in.
The only reason they're not gonna move in is if something really bad goes on in their life, like they get laid off or some other financial scenario. Otherwise, they are deeply committed to the home, and we believe our cancellation rate will, over the long term, be structurally lower. So those are the benefits in our mind of this move-in-ready strategy, but I wanna just go back to the thesis. The thesis is we believe when the market, the used home market, comes back and new home market share goes back to a more normalized percentage, we wanna stay and compete in that 80% versus the 20% that all the other new home builders are gonna be competing against.
I believe the idea of holding your inventory longer and waiting it to release is gonna be difficult for a lot of builders to get their heads around because that means they're saying no to a customer that wants to move in, in a different timeline.
So I'm gonna, I'm gonna add a couple more points here. So I think it's, it's you guys have already been seeing it, right? Our WIP units are increasing, not necessarily per store, but you're seeing the total WIP units increase. But the flip side to that is backlog's decreasing because it's moving, it's turning so quickly. For us, WIP and backlog are now the same word. When you're selling and closing everything in 90 days, that's the same word. So there will be an additional burden on our balance sheet, but not as high as one might imagine, because the backlog is turning so quickly, so those units just convert between one and the other. You mentioned that there's other folks that are also jumping into the spec building. It's a great place to be, so we understand why they're jumping in as well.
But it takes courage to do what we're doing, which is shut down the design studios and don't give a second alternative. When you build a spec, it's nice, but then you're gonna have to discount that spec if someone can go in and customize it 100% the way that they want it in a design studio. I think that's kind of the arbitrage, is you have to have confidence in your interior configuration and the design selections that you're making, and have enough specs available so the customer always feels like they have a choice. Because reselling that home, if it does can, which is rare, or selling it, provides enough optionality to the customer, then when they come in, they see it as having the selection, even though we pre-selected what's there. So when you look at it, we always get questions on the backlog conversion.
Is this because the cycle time is improving? If the cycle time pulls back for some reason, will you still be able to hit the 60-day commitment? Well, the 60-day commitment is at our leisure, right? We decide when to release a home. If the cycle time is longer, we're gonna release it later in the process. That 60-day commitment is based on a significant amount of research to align with what the consumer wants. When we choose to release the home for sale is at our election, and we know that we can do it with 60 days to close. In better cycles, it can be at cabinetry. At later cycles, it's pretty much a warranty walkthrough. But we know that we have the option to release it at that 60-day timeframe, that 60-day timeframe. We keep on saying 60-day guarantee, 60-day guarantee.
What does that mean? So I think you guys can recall, not to bring up a difficult time in our lives at the beginning part of the year, but there were two cyber events on some mortgage providers, and two cyber events on title insurance providers. All of us got a crash course into what it means to have customers not be able to move into their house when they wanted to. And although we've all been in home building for a very long period of time, that reality of what happens on the consumer side became very, very stark. They sold their house. They exited their rental contract. They don't have a place to be. They need to get a hotel or stay with someone. They have to find something for their pets.
They have a moving van with all their stuff that they're paying by the day. So these are kind of the issues that plague both customers and brokers, right? When they're looking at transacting with a home builder, they are saying, "Okay, I'm just this little guy trying to buy a house, and there's this big, massive corporation. And they're just gonna tell me when I'm moving in, and they don't really care if it works or doesn't work for me, and the consequences that come with it." So we're trying to solve for that, first, by making sure that we don't release a home for sale without being ready to close it in 60 days.
But if something were to happen, and it wasn't outside of our control, something were to happen and we couldn't get them in that home when we said we were gonna get them in that home, there's a guarantee. We're gonna help you out and make sure that there's not a financial implication for you to not be able to get into that house. So that not only gets us on par with resale, but maybe even a step above it.
Great. No, that makes a lot of sense, and I think the strategy is sound. Just to kind of frame this, Phillippe, I don't know if you have the data handy, but I'm curious, you know, given that you've been in this spec strategy for a while now, what percentage of your closings in 2022, 2023, were sold and delivered within 60 days? I'm just trying to get my arms around how much of a sea change this new guarantee is for you.
Oh-
I don't-
Less than 15%.
Almost none of them.
Okay.
Yeah.
I mean, we were willing to take any customer that, as long as it was started, right?
Yep.
We were selling it, so... And we certainly didn't have the cycle times we have right now. Obviously, we're still working through the supply chain, so I'm not even sure if those are great data points because of the backdrop. But either way, it wasn't even part of our strategy, and we weren't starting specs to support a 60-day move-in in. In fact, if we weren't selling specs in a community, we were probably slowing down starts. Now we're like, "Look, let's keep starting, and let's make sure we sell these 60-day, 60-day home." So it was very, very low, and now, I think we reported this in Q1. And we had 140% backlog conversion rate. But all the way through the first 2 weeks of the second month of the quarter were all homes that closed in the quarter.
So almost all of, you know, almost what percent of that would be?
Yeah, 48% of our transactions in Q1 closed in Q1, and about half of our homes. I mean, this is kind of the same math, but about half of our homes closed in 45 days or less.
Yeah.
So that 60 days actually even giving us a little bit more breathing room than what our teams have been able to roll out. So I think maybe we should have set it up. This is our strategy going forward. It's something that we're rolling out throughout the country. It's not live 100% everywhere. We're making sure that we have all the right tools in place when we go live 100%. But if you're visiting our communities, you're probably hearing this in many of our locations from many of our sales agents. This is already live and in place in select geographies and will be fully operational in 2025.
Yeah, I think that's really important. We're not there 100%. Even with the new communities we're opening up, we typically try to get momentum early in a community. We're now waiting to open those communities up until we have 60-day move-in-ready inventory. We used to say, "Let's open it up once we have spec inventory." Now we're saying, "Let's open it up when we have move-in-ready inventory." So we're not migrating there. We haven't migrated there fully. There's still a lot of work to do. Not all divisions are set up effectively to do this just yet. But we're getting there, and we plan to be there by the end of the year.
I think the other thing I wanted to highlight was, you know, it'll be interesting to see how this shows up in our seasonal pattern for us versus other builders. You know, are we gonna continue to see all these sales in the first part of the year, and then less sales in the back half of the year? You know, we were talking today about having a very aggressive July sales because we think we can move people in before the school year starts. We typically don't have a lot of sales activity in July because we can't move you in before the school year starts. Now, we're gonna be able to move you in for the school year. So it'll y ou know, we're still studying how this is gonna affect how we operate within seasonality.
We don't think we're gonna be immune to seasonality, but it might show our trends might be a little bit different. They might look a little bit more like the Hortons of the world, the Lennars of the world, who also sell only spec. But the 60-day move-in maybe even help us out a little bit more.
Got it. Hilla, you brought something up about, I think, community count in there, which was interesting, and somewhat of a nuanced data question, but I'm sure some analysts on the line might be curious. So are you actually not counting a community as actively selling now until you actually are within 60 days of a delivery timeline for a community?
Yeah, I mean, we don't count a store open until we get a sale.
Right
And we're not releasing, we're not releasing homes for sale in our new communities until we have 60-day Move-In Ready. What that means, though, is we'll get closings in that community 60 days later, right?
Right.
So we're just carrying the inventory till later in the cycle before we open up the community for activity, which is changing our sales and marketing strategy as well. You know, as far as building up the interest list for the community, as far as how we're thinking about models and signage, and all the dollars we spend getting ready to open up a community, things are very, very different when you have 60-day move-in-ready inventory, and we're studying, you know, the appropriate sales pathways when we're when we open up a new community.
I think you guys saw that in Salt Lake, where we reported both sales and closings for the first time in the same quarter.
Right.
So it's definitely something that we're hyper-focused on in newer locations, where we can't implement the strategy live. We're seeing great success. I think maybe this is a good time, Phillippe, if you wanna. We keep on saying move-in ready, move-in ready, but we-
Mm-hmm
haven't really explained what Move-In Ready is. Maybe this is a good time to walk through what that means.
Yeah. And again, we differentiate between the 60-Day Move-In Guarantee and Move-In Ready because 60-day guarantee is more just about being Move-In Ready on a timeline. But the other piece of this is the home being turnkey from a consumer's perspective, them not feeling like when they buy a used home, literally all they have to do is get their Wi-Fi turned on and move their furniture in, while when you buy a new home, there are other things that customers perceive, Realtors perceive, that has to happen to get the home turnkey, if you will.
Whether it's ceiling fans or blinds or landscaping or setting up certain things in your home, whatnot, there's this idea that the home isn't turnkey, and so we're very focused on what the incremental features that we need to put in our homes so we can remove that objection. I've mentioned a lot of them, but there's substantial things that need to happen from that perspective in order for that perception to be true, and those are gonna increase our direct costs. We're absolutely going to put more features in our homes than a traditional spec home has to make sure that it is perceived turnkey, but we're gonna leverage our scale and our business to do that.
To get really granular and specific, because I wanna make sure people understand this, all of our homes are gonna become with the appliances in them, and that includes washer, dryer, refrigerator, microwave, all the appliances that you would think you would get when you buy a, when you buy a used home. And our ability to go negotiate with our national vendor and secure those appliance packages is significant because we're building 15,000 units, and we have this growth story to go from there. We were able to go negotiate a deal to allow us to throughput, something that I don't think we would've been able to do at 9,000 units or 10,000 units. I also don't think we would've been able to do if we weren't 100% spec.
If we were offering customization and design studios, we wouldn't have been able to go really buy a spec-level appliance package across our entire national footprint that makes us extremely competitive with the used home market. So we're gonna put in the move-in, turnkey-ready features in these homes so that our customers don't perceive that there's any trade-off when they go buy a used home versus one of our homes. Same thing, go buy your furniture, get your Wi-Fi set up, and move in.
Did we lose Alan?
Are you there?
I'm here. Can you hear me?
Oh, yeah-
Yeah, do-
now we can.
Were you able to? We got a little bit of a glitch. Were you able to capture all of what we said?
We're in.
That one.
Okay. I think Emily says she can still hear us, and she's in another room, so I think we're okay. We'll keep on going. So I think-
Okay
It's really important. Oh, no, here, you're back. I think, I think it's really important to just double down on what, on what Phillippe just said. Again, we're obsessed with research over here, so we've done a tremendous amount of homework to understand what features, a customer would reference if they're saying, "If I'm gonna buy a used house or a new house, why am I picking one versus the other, and what is important to me?" And it's primarily items that, they feel they need at move-in day, right? You definitely need a fridge at moving day, maybe blinds if you have young children and you don't want, their windows to be visible from the outside.
So we definitely did our homework to understand what they value, which is both a hindrance to move in if you don't have it, and trying to schedule everything to come and happen at the same time, but it's also financial, right? If they're saving the money for the down payment to move into the house, and the furniture, as Phillippe alluded to, to now also have this another financial burden of trying to get the house to livable state, to move-in ready state, was another fear that they had when they committed to a new home.
So again, in our quest to look as similar to resale and eliminate or neutralize any objections, this is another step in that path to help both the customer and the broker that's directing their research align us with what they perceive as value in the used home market.
Just one last thing to share, you know, as you think about how people go and shop for used homes on Zillow or MLS or whatnot, and what our consumer research told us is how they also eliminate homes from their search. One of the reasons new homes get eliminated often in the search is because when you go look at the pictures of the home, you don't see the home looking like an existing home, right? You go take a picture of the laundry room, and the laundry room is just a bare laundry room. You go to the kitchen, and the kitchen doesn't have appliances. And most customers, especially first-time customers and 1MU customers, focused on affordability, they'll just eliminate you, and the Realtor will also just eliminate you as they go through their search.
Part of this is not only delivering on our customer promise, but part of this is also being able to market our product in a pathway where typically new home builders are... new home construction is eliminated.
Got it. Can you hear me okay now? I think everything-
Yeah
seems to be running smoothly.
We hear you guys.
Perfect. Okay.
Yeah.
Got a few good questions in here in the chat box, so let's ask a few of them. This one's from Carl over at BTIG. "Clarifying turnkey, does that mean you'll be doing landscaping on all new homes? And if so, how do you determine what features to include, how do you leverage scale, and what does this do to the warranty contingency?
So I'll let Hilla take the last piece, but we're gonna do landscaping to the extent that we're allowed. Unfortunately, with new home construction, there are a lot of municipal and regulatory environments that don't allow you to do the landscaping that you might do that a homeowner might do to their own home when they live in. So we're gonna take it as far as we can within the restrictions we have. As it relates to what are we putting in our homes, it's, it's just the research, right? We've researched a ton of this. We've researched every market, specifically, what is your expectation? What are the features, whether it's what's actually going in the home versus what's in the outside of the home?
We have a ton of research to kind of guide what turnkey truly means and what they specifically are looking for to make that trade-off behind buying a used home versus a new home. We're gonna eliminate as much as we can within the constraints we have, and landscaping is just one of those ones that is market by market, municipality by municipality, developer by developer. Unfortunately, we won't be able to leverage national scale from that perspective, but we're big enough in all of our markets. We're a top five builder across all of our markets, a top three builder in many of our markets, and we'll be able to get significant pricing on a landscape package.
And we already do landscape in the front, right? So most HOAs won't let you move in without. So we have the relationships and the contacts already. It's just also leveraging it for the backyard, right? People don't wanna move in and it's a pile of dirt in the back. Now, it doesn't mean that we're gonna put in the fanciest configuration in the backyard that's gonna be, you know, your dream vacation spot, but it's gonna be livable and usable when you move in. If you wanna upgrade after you move in, you're probably gonna do that in lots of areas in your house. But we just wanna make sure that when you move in, you feel like your home is usable on day one, and we're not creating a negative differentiator between us and used homes.
Not every used backyard also looks exactly the way that you'd want it, but you can have your kids running around outside. So that's really what we're looking for, and the warranty is the same. It's the same as all other trades for us.
Got it. Great.
I, I-
Got a question here from,
The warranty's a-
Sorry, Phillippe.
Sorry. So the warranty is an important part of this, though, because it's amazing that so many people will buy a used home and just get a homeowner's insurance policy and hope that everything works out. They'll get a building inspection, and, with a new home, you obviously get a warranty, a two-year, where we cover everything, and then a 10-year, where we cover any structural changes. So, you know, we think if we eliminate all these other objections that we've called out, the warranty becomes a huge selling proposition against the used home, especially for affordable, entry-level customers, first-time homeowners, which is our primary buyer.
This is really where we hope to leverage the Realtor, right? Phillippe alluded to it in the prepared remarks, but if you buy a car, that warranty is worth everything, right? That's why people love the new car. You know that if anything goes wrong, it's gonna be probably a large dollar repair, and so it's the likelihood is low because it's a new car, but if it does happen, it's on someone else's dime. I don't think that we've done a good enough job as an industry, demonstrating the worth of that package. So this is another area where when we talk a little bit about our Realtor relationship and what we can do for them, there's also some things that they can do for us.
There's a lot of unique differentiators between new and used product, and this is, this is one of the areas where we think we have an advantage that maybe hasn't been marketed as well as it should in the past.
So I definitely wanna pivot to the Realtor conversation, 'cause I think there's a lot there. But I wanna kind of put a bow on, on the, the Move-In Ready Spec strategy first, 'cause there's a few other questions on that topic. I think we kind of touched on this a little bit earlier, but this is a question from John at UBS related to, you know, does waiting until homes are within 60 days of being complete materially change your community count outlook? And how many homes in a community need to be within 60 days before opening that community? And there's a follow-up to that also-
Yeah, this is all built into our guidance. We've guided to high single-digit community count growth this year. We've guided to more meaningful, double-digit growth next year, and this doesn't change anything. We've built this strategy into that trajectory, so. Every single one of those communities will open up with move-in-ready inventory, and, and we're planning accordingly. We build specs, and we offer interior packages that go with those specs. We've streamlined our operations significantly. Of the, you know, 14,750 units that we're guiding to this year, we're building that off of a plan portfolio of around 350 plans. That's it. Company-wide, we have 350 plans from coast to coast.
So when you think about our typical community, we offer four to five plans, three to four different packages that offer light cabinets versus dark cabinets, tile flooring versus an EVP type of flooring or whatnot, a couple different flooring styles. So our ability to carry those, those four to five floor plans with a couple of different choices is all built into, into this plan. Obviously, you see our WIP growing because we're carrying more of that product later, so you have choice. We wanna offer customer the choice, but the choice is, do you want this floor plan or that floor plan with light cabinets or dark cabinets?
We're gonna offer enough choice so that we can meet you on your lifestyle, whether you have two kids or three kids or one kid or you have no kids, wanna make sure we have the floor plans to meet, to meet you, meet you. But once again, back to the automobile industry, right? You go into a car lot, you've decided what car you want. We're gonna have the black, the white, and the blue one with the leather package and the other package, you know, et cetera, and we're gonna have those in all of our communities, and that's built into. We've been doing this for a while. We just haven't held them until release.
But we've already been operating in that environment for some time, where we've offered that choice in the form of the number of specs we offer, so that we have the variations that you'll need for your lifestyle. This is just about waiting longer and carrying them longer until they're released.
I think there's a really important point in what Phillippe just mentioned. With a very skinny plan library, only 350 plans, if you think about our communities or if you've been on our website, you can see that our communities are typically kind of clustered together. There's some in this part of town and some in that part of town, but they're not everywhere. So when you're carrying enough inventory, if an incoming customer is interested in a specific floor plan, we've kind of been programmed to sell it at this community. But if you think about how a resale customer looks at it, they're looking at a general geography. They're saying, "What's rolling into the school district? What's close to my office? What's close to my family members?" They're not necessarily married to, you know, the latitude and longitude of one community.
That's, that's your own implication that you put on that request from them. So when we look at what's available to us and we try to think, how does a resale customer view available inventory, we have opened up the opportunity for our sales teams to sell whatever product makes sense for that customer. Because it's so limited, we know that if they liked it in this community, they probably also like it in the community that's a mile down the road.
Mm-hmm. That actually kind of ties in a little bit with John's follow-up question, which is: Is there a market share level or size, you know, units per year, you know, in a particular market that you view as ideal for this strategy? Because, say, I would imagine there's economies of scale there, where the more inventory you have, the more options you could provide that buyer to compete with the resale market.
Yeah, you know, we're looking at it a couple different ways, but our belief is that when you look up, as we're the fifth-largest builders, we look up, we see four builders above us, right? We see NVR, Pulte, Lennar, and Horton. And it's really NVR, then there's a big leap up to Pulte, and then Lennar and Horton are in a different stratosphere. But Lennar and Horton are the two biggest, and they're, if you go into their markets, their submarkets, they're the number one or two builder pretty much across their footprint. We feel that as we focus on affordability and we focus on entry-level and spec, you know, being a top five builder by market isn't probably the goal. The goal is to be top three.
When you're focused on affordability, when you're focused on volume, top three seems like the place you wanna be in every single market. So that's the market share we're looking for, is a top three position. People ask me quite a bit, you know, "What does it look like from 147 to wherever you guys are going? And can you do it in your existing markets, or do you have to go into new markets?" There's always new markets we're looking at and interested in. We've went into four in the last three years with Jacksonville, Myrtle Beach, Charleston, and Salt Lake City. But we also see a path to get to where we want to go just by getting into the top three in every single one of our markets.
I would argue that Lennar and Horton think about the resale market similar to us. They probably are choosing to compete in that market differently than we're talking about, but I imagine that they think about the resale market and how do they make sure that their product stays into that consideration set so they can get a bigger part of the market share. So I think we're thinking about it that way, and then when we think about the new home market versus the used home market, we're gonna start thinking about, you know, how are we capturing. What percent of the used home market are we capturing in our respective MSAs as well as of our submarkets versus what percent of the new home market are we capturing?
And this is, this is the most interesting thing about the research that we've seen, is that even in submarkets where there are plenty of us building new homes, the resale market, the used home market inside that submarket and adjacent submarkets, right? Not way closer in submarkets, but just the next submarket closer in, the used home market is still 60%-70% of that market. Even though you can go and buy a new home, customers are still choosing to buy a used home versus a new home when the price differential is negligible. And frankly, the two submarkets, there's not a big difference other than maybe a five to 10-minute commute time.
That's what-
Gotcha
the strategy's trying to solve for.
Got it. Got it. Let's talk pricing a little bit with this strategy because, you know, I and maybe this is wrong, but there is you know, generally widespread belief that pricing on spec product tends to get more challenging as you get closer to delivery. And I know some of that is related to maybe inventory that was canceled, or maybe there was, you know, specifications added to the home through the design studio, which clearly you're not doing. But but even Lennar has kind of talked about their dynamic pricing model, where they've got the red light, yellow light, green light kind of pricing, and as you get closer to the home being complete, that's when they get more aggressive on incentives and discounts. So how are you thinking about pricing on these homes?
Once you hit the 60-day mark, is there a dynamic pricing lever in place as you get to 40 days, 30 days, 20 days away from completion?
Yeah. That is a can of worms. So I think number one, obviously pricing is the key to the strategy, right? So I don't think this strategy works if you're not focused on the first-time home buyer, and you're not focused on inventory management, and you're not focused on competing with the resale market. If that's your strategy, then pricing is ultimately the key to the whole thing, right? So if you're not priced right, you're just not gonna sell homes. That's number one. So we're not gonna do anything different than Horton and Lennar when it comes to pricing. If our homes aren't selling, we're gonna adjust the price and sell the homes.
Because we're gonna keep building homes behind those homes, and it's all about price so that we can go and negotiate with our trades and get the right cost. So that's not gonna be any different, that here than there. That being said, as we've demonstrated up to this point with our third-best margins in the industry and the absolute best margins for all entry-level and spec builders, we believe that through your product strategy, we believe through your inventory management, your locations, you can still achieve really good margins and, make sure you price your product appropriately.
We also believe that if you compete effectively with the used home market, and you take the new home market out of the conversation, there should be a premium for our product because we are also a move-in ready, turnkey home that a Realtor can put a customer on, and they can make no compromise and buy a new home. And we believe that there should be a premium for us to be able to deliver on that timeline and deliver a turnkey, turnkey home. So, you know, we're confident that as we carry homes later into the cycle, we're gonna have to discount them less because they are gonna be turnkey.
But at the end of the day, it's all about being priced right in the beginning, to really make sure that, you know, you're not having to over-discount your product because you're building too much specs. They're not selling. You're carrying them too late. Consumer research, make sure you have the right floor plans, make sure you have the right features in the home, and then, you know, price your product appropriately.
I mean, I think just to jump in, the product only is available at 60 days, right? So there's not that, that's the first time a customer is gonna see the price, so there's quite a bit of time for us to still close on the home anytime that we sell it. This is a strategy that was established with all of our partners, right? We know that our mortgage team can get it to the finish line on that time. We know that our escrow and title team can get to the finish line. We know all of our construction partners are able to get us to the finish line on time. So the first time, it's a scarcity conversation, right? It's not available until 60 days.
For the first time, so we don't anticipate having to have a lot of discounting. I think as you alluded to, obviously, you know, at some point, if you're holding it for a year, you're gonna have to do something. But selling it in day 60 or 45, for us, that's kind of the same, right? As long as it's closing on time or very, very shortly within when it's available for sale, it's intentionally timed to go and to be priced at a point in time when we're ready, the customer's ready, and we close the house.
So again, I know we keep on deferring to the automotive industry, but someone put a deposit on a car, and then decided they didn't want it, and it's still on the lot, and you come and buy it, you don't know that it was someone else's car.
Yeah, right.
It's just the car that you want, right? It doesn't have anything in it that's different or unique. It's the car that you wanted. There's 15 of them, and you fell in love with this one, and this is the one that you bought. So the fact that it's a spec is a positive for us, not a negative. We have enough of them that you will find the combination of floor plan and interior configuration that works for you and your family. And there's no discount, there's a premium because you can move in. Again, this focus on the entry-level and first-time move-up, a lot of the folks don't have a place to sell. They have to give their landlord 30 days notice, and they're moving in, or they're a customer that's ready to move in quickly.
As Phillippe said, if 120 days is your timeline, that's not our timeline. Get your home under contract, come back, we're gonna have the exact house that you want. Maybe it's four, maybe it's four lots over, but we started exactly the same house that you wanted anyway. It's in our inventory, and we'd love to sell it to you.
I think the other thing, too, part of the secret sauce with Meritage Homes, starting with our strategy in 2016, but even becoming more relevant today, is that we just have tremendous alignment with our product and our features that go in our homes nationally. So I think sometimes with these specs at a local level, you know, the division president or the sales leader is really driving what's going in a spec. And for us as a company, we have so much. All of our packages, all of our feature levels, our product alignment is really, really tight, and we have people at the national level doing tremendous amount of consumer research, making sure that we have the right floor plans with the right features in the home.
And so when you have to discount something later on, when you have something coming behind it, 90 days behind it, that's exactly the same, then you have a bigger problem, right? Because why would the stuff that's coming in 90 days be any better than the stuff you have in 60 days? You probably got it wrong in the first place. So we just don't see, when we have consistency and alignment at the national level, and we've done all this consumer research, that you should ever have to discount something that's 60-day move-in versus something that's 90-day move-in, that's literally exactly the same as the 60-day move-in inventory.
Got it. So it sounds like really until the completed inventory were to accumulate on the balance sheet, that we shouldn't expect to see any material differences in pricing or margin, you know, given this strategy shift.
Yeah, I mean, we're not gonna be immune to the macro climate. Obviously, if there's pricing compression, whether it's sub-market level or, you know, at a larger level, we're not gonna be immune to that. We'll have to adjust prices accordingly. But we certainly don't feel like we have a business strategy that is set up where we have to discount product because it's ready to move in versus product that's coming behind it.
Got it. Makes sense. A couple of questions that are related here on this topic. What is the average price differential between turnkey and kind of the more traditional finished spec, like perhaps you and others were doing previously?
Uh-
How do you maintain affordability while adding these extra features to make a home move-in ready?
Yeah, it's-
And-
it's not a lot-
Sorry, those questions are from Susan at-
Yeah
Goldman Sachs and Paul at Wolfe. Thanks, guys.
Yeah, it's not a lot. We haven't costed out everything nationally yet, so I don't want to put a number just out there yet. But, you know, it's not a lot that we're talking about that we're putting our in our homes to kind of remove this idea that we're not turnkey ready and allow us to market our product effectively via the existing home environment. The other thing I would say is that our scale really helps us here. Our scale and alignment, we're gonna buy the same appliance package for all 14,750 houses. We're not gonna have a different appliance package in Florida versus Texas versus California. It's gonna be one package. So I think our scale is allowing us to get really, really good costs here, and there are potentially some offsets in some other places.
So we're not ready to put out a number, but, it's a number that we've kind of fenced in, that we believe isn't gonna impact our ability to effectively still compete in the affordable segment of the market.
It, I'll say it this way: It's a low enough number that when you add it to the revenue, the cost component to the revenue, you should be net neutral, and it's something that would be in the neighborhood of what we would have in regular price increases. So we're talking a very, very low number. As Phillippe said, the savings that we've been able to harvest from our trade partners are material enough that it's a very, very small increase in the price and cost of the home.
In my wildest imagination, I never would've imagined that we would've been able to go and negotiate the cost we have on this when we were smaller and when we had so much complexity in our business. But our ability to go out there and access this is completely different today than it was in the past, which makes it something that we can essentially do, and still feel really good about where we're gonna be positioned in the market and what our cost structure's gonna look like.
It lets us punch a little bit above our weight class, in all honesty. Some of the bigger guys, the four that Phillippe mentioned, a lot of them have also streamlined operations, but when you're picking six different configurations across, you know, 50,000 units, it's kind of less than what we're willing to do if it's one configuration across 15,000 units. So the savings that we're harvesting is probably above what we had anticipated when we first put pen to paper, and so it's allowing us to charge what we want to for this incremental move-in package. And it's fairly agnostic for the consumer.
Yeah. I would say also the last thing on this point is just similar to the 60-day move-in guarantee, we're not there yet, right? In some of our markets, in some of our communities, we're doing this, but in other communities, we're getting there.
Mm-hmm.
So our commitment is by the end of this year, all this that we're talking about is gonna be in place from every single community, and we open up every new community, we're gonna open it up this way. So, you know, we're still in flight here as we sort of take the plane apart.
Got it. That's great. Question from, this is from Surveyor Capital. You know, you've talked a lot about competing with the resale market, but we have spent a little bit of time discussing Lennar and Horton, which are two builders that are bigger than you guys, but also have seemingly have fairly similar sales strategies. So, you know, where, if anywhere, do you see yourselves as disadvantaged today that you're looking to address going forward to maybe narrow some type of gap versus those two builders on a cost perspective or anywhere else that you could foresee?
Yeah, I'll take those two separately. You know, Horton's always gonna have a better cost structure than, I think, anybody in the industry, just purely based on their scale and their focus on being the low-cost producer and really being. You know, take LGI aside, I think LGI is just focused on a completely different consumer, but when you take them out, Horton is always gonna have the best cost structure, and I don't think we ever, even when we rolled out the first part of our strategy, and now as we roll out, roll out our second part of strategy, we ever thought we were gonna have a similar cost structure.
We simply just put more in our homes than they're willing to do because we're trying to focus on the first-time homebuyer that just wants and is willing to pay for a little bit of a nicer home, and we've been able to effectively do that quite well. When I first got to this company, there was a mantra: "We do not build next to Horton and Lennar, because they will just destroy us, and they're all about volume." Well, now we build all over the place next to Horton and Lennar, and we do very, very well because we get the customer that just is looking for a little something nicer. They do very well, too. There's enough of that buyer pool for us to share.
So I don't think we'll ever have the same cost structure as Horton, and we don't expect to, and we always feel like we can be priced somewhat higher than them and still go get enough customers. Lennar, similar, I think they probably have a better cost structure just because they're so much bigger than us, but other than that, I think we match up fairly well with them. So other than their scale, I think our cost structure competes with them very effectively. They also, I think they're much more decentralized than we are. We're much more centralized when it comes to our product. I think they still allow their local operators to offer different product and features.
Everything included is everything included, but the DP and the sales leader get to decide what's included, while we have a much stronger national alignment, which I think helps us play off each other a little bit differently. I think where we think we compete with Lennar differently, though, is in our sales and marketing strategy, which is a great segue, Alan, if you're okay, for me to talk about the third sort of pillar of the strategy and third kind of evolution of how we're thinking about the next step here.
Absolutely. Yeah, no, let's go to the Realtor, you know, focus because frankly, every question I've been getting over the last few months is, well, how much money can builders save by either reducing broker commissions or reducing reliance on Realtors because of the NAR settlement? It kind of sounds like you've got a little bit of a different vision given, you know, you're, you are trying to compete with the resale market, and you're kind of viewing the broker brokerage community as a, you know, a real tool for that. Maybe just talk a little bit about what seemingly are kind of diverging, you know, views on brokers right now and how you're thinking through that.
Yeah, I'll probably meander around a little bit here in this conversation. Just to start out with our view of the NAR ruling, you know, we think the biggest outcome of that is gonna be transparency. Just an extreme higher level of transparency that currently doesn't exist. And obviously, we're a builder built on transparency, so we think transparency can only allow us to be more effective with our customers. Customers thrive on transparency. When things are clear, it makes them feel more confident about their decision-making, and so, the more transparency in the process of buying and selling houses is only gonna help transactions happen more effectively, and customers feel better about that. Obviously, the other outcome of transparency is going to be cost competitiveness.
There's gonna be a natural, ancillary benefit to this, which is gonna create more cost tension, which may drive Realtor costs down, both on the sell side and the buy side. We'll see. So we, we agree with all that. So we're not arguing that there's probably an opportunity for those costs to go lower, from this outcome. You mentioned two things. You mentioned, will this help with costs? And then the second is the reliance on Realtors. This is probably where we are going in a different direction. Our research tells us that specifically with our customer, the first-time homebuyer, their confidence level in buying a home without a Realtor is really, really low. They may do a lot of their research and their due diligence, online.
They may be more comfortable buying a home through that pathway or starting to secure a home through that pathway, but when it actually comes down to transacting, negotiating, getting the contract done, and closing a home, our research comes back resounding that the first-time homebuyer is gonna buy their first home with a Realtor. So we believe the customer's reliance on the Realtor will stay very, very strong. You know, we also believe that the Realtor adds a lot of value in the home-buying process. The Realtor is the trusted advisor. They help steward that first-time homebuyer through that process. There's a lot of anxiety, there's a lot of stress.
We've certainly tried to take that away through our operating model, create more transparency, et cetera, et cetera, et cetera, move-in certainty, with the 60-day move-in guarantee, turnkey-ready, so you don't have to worry about the extra cost when you move in. But there's. Even with all that, it's your first home. It's the first home you ever bought, and I guarantee you, when you're sitting around the dinner table, or you're sitting on TikTok, and you're talking to your influencers about buying a new home, one of the suggestions is, "Make sure you have a Realtor," right? "Don't buy a home without a Realtor." And they just- we don't believe that changes with our cohort, which is that first-time homebuyer. So we're gonna lean into our belief that this- they play a critical part. We're gonna partner with them.
We're gonna work with them in a way where they are truly a partner, an inside partner to our business. We've often looked at Realtors as sort of they're a necessary part of the transaction, but they're not one that brings a lot of value. We think when you're competing with the used home market, they bring tremendous value. They steer their customer to the product that they have the most confidence in confident in selling, and they'll do the same for us if we can create that connection and create that relationship. So there are a lot of opportunities other than just how you pay your commissions, when you pay your commissions, the transparency in your commissions, which I think all of us are gonna be thinking about how we operate in that environment with the new ruling.
But there are a lot of things that we do as new home builders that really don't create strong connection and partners with the Realtor community, and that's why they steer their customers to the existing home market. So we're going the other way. Now, that doesn't mean we're gonna be paying above-market-rate commissions, right? I would argue that Horton, when things don't happen, the first lever they pull is commissions. They pay higher commissions because they believe that the Realtors will start bringing more customers to their product, and then the next thing they do is adjust their pricing. Lennar is effectively, and I don't think I'm saying this unfairly, but they have definitely come out and said, "We think there's a way to just remove the Realtor from our business.
We think customers will buy our homes without a Realtor, and we can solve that in a different way." We don't believe that. We don't believe with our first-time customer, they're gonna buy a home without a Realtor, and that Realtor process is really important. So we're gonna try to partner with them. We're gonna try to lean into that relationship. We're gonna try to create value. We're starting to develop a mantra that the Realtor is our customer, so how do we show up as someone who- how do we treat them as a customer, not only our homeowner? So what does that mean from a financial perspective? And you started to see this in our numbers, too.
In Q1, one of the reasons our SG&A wasn't exactly where we wanted it, although it was better than we thought it was because we got incremental leverage, we used less rate locks, and we had some pricing power, but our co-broke, which is how many homes we sell with a Realtor, is starting to go up. We've typically operated between 65% and 75%, and now we're north of 80%, and really the goal is to go higher than that. We believe our ability to sell 60-day, move-in-ready, turnkey homes is really critical that a Realtor helps us do that, that supports that process. If we're gonna carry homes later into the build cycle, and we're gonna put more cost in our homes to make them turnkey ready, we're also gonna lean into the Realtor to help us do that.
Hilla may have something to add.
Yeah. I think, you know, if you think about the population of home buyers, as Phillippe said, you know, if 60%-70% of transactions occurring around where we are are not new home stands to be a reasonable assumption that when someone is looking at a home, some people just say, "I want new home construction," and that's delightful. But some people say, "I don't know what I want. It's my first house. I'm gonna look at a whole bunch of stuff," right? So when you think that a used home may be in your decision set, for sure, you're gonna want a Realtor, right? For sure you're gonna want a Realtor, 'cause the other side's gonna have a Realtor, and there's gonna be an inspection process, and you don't really know.
Maybe you don't know anyone in the mortgage industry, so you're gonna want that connection. So if that Realtor is already connected to that customer, we wanna make sure that we're reminding both the Realtor and the customer that we are an equal or maybe even better choice. We don't wanna be eliminated. It's not a question of, are they or aren't they coming in with a broker, or are they or aren't they adding value in the new home process? They already have a broker. It's already part of their starting point.
So how can we possibly not embrace the broker and say, "Please make sure that our homes, and try to make our homes as easy," as Phillippe said, "to our two customers," the customer and the Realtor, that when they look at it and say, "Yeah, this is, this is also a product we should tour this Saturday when we go look at all the houses," and make sure that our home shows up as well as or better than everything else that they're looking at, and embracing the broker relationship to make sure we just, you know, expanded our internal base by thousands and thousands of sales, sales teams, right? If they're selling our home as well as we're selling our home, that's just additional firepower for us.
Makes a lot of sense. This is interesting-
I would say that if the cost-
Sorry, Phillippe.
If the overall market cost of commissions is driven down, you know, we believe we'll benefit the same way as everyone else. But-
Right
if there's benefit to completely cutting the Realtor out, we're not gonna see that in our numbers, because we're certainly not going in that direction.
Got it. Got it. Jay from Wedbush has a question here, which, you know, I'm sure you would say the gap out risk at this point is fairly low, but the question is: how will you keep Realtors engaged if you do gap out in a market or in multiple markets? We see that as a real risk to this strategy, given the recent history of gap outs.
Yeah, I mean, absolutely. So, a lot of the gap outs that we've experienced over the last three years, I think, were because of what we experienced over the last three years, right? The volatility in the market, supply chain shock. So, you know, if we go into more volatility, which creates gap outs, we're gonna struggle, like everybody else. And to your point, if we don't have product, then we don't have a story to talk to the Realtors about. Now, that all being said, Hilla kind of alluded to this earlier, but I think we're starting to think about communities a little differently, right? We're taking large concentration in sub-markets where we have multiple outlets.
Hopefully, we'll have enough product in the sub-market to always engage with our Realtor and our Realtor friends versus on a community-by-community basis. So that's part of the overall strategy. But, you know, the other piece of this is just, frankly, we just have to be better than the industry at not gapping out, and we recognize that in planning our business, our land pipeline. I think this is why builders are starting to do more off-balance sheet financing. Maybe it's a way to prevent gap outs in certain ways.
But for us, it's critical that we don't gap out, and we have to sort of evolve our business from a production standpoint, so we don't, because we won't be able to keep our Realtor community engaged if we don't have product to sell.
Again, this is a conversation when you're thinking about resale. When you're looking to buy a resale home, you're typically not saying, "I wanna live on this street," 'cause you can wait a really long time for a home to be listed on that street, right? You wanna say, "I wanna live in this area." Well, we're gonna make sure that we have enough inventory. We'd love to have all the right product in every community that people are looking for, but minimally, we're gonna make sure that we have enough in that geographic area, that if we're not hitting this one, exact location that you want, that we have something that's very, very similar somewhere else. The broker is probably the easiest sell in that discussion.
They know that they are sometimes gonna have to drive to a couple of different locations to get the ultimate home buyer comfortable. So it's just kind of getting that mind shift to say, "Well, resale works that way. Sometimes also new build works that way, so it's not in this neighborhood, but a mile down, we have something that you want.
Got it. It kind of ties a little bit into what you just said, Hilla. Jade from KBW has a question in here: "How do you compete with existing homes on location?" And I'm guessing he's coming at it from the angle of, you know, traditionally you think of new home communities maybe a little bit further out, not necessarily right on top of resale, and yet you're targeting, you know, competing with the resale market. So are you changing, you know, in your underwriting, where you're looking for communities to be more aligned with kind of infill existing home markets? Or I'm not sure if I'm interpreting the question perfectly, but that's-
No, it's a good question. And I think, you know, if you wanna live in Scottsdale, Arizona, then you're not our buyer 'cause we don't have any product in that location. And as you look at our MSAs, when we look at our competitive set, we're looking at location a little bit differently. So there's always gonna be existing home product that's closer in than us, but there's absolutely enough existing home product that the trade-off isn't that meaningful, where we're looking to compete directly with that. And as we've said, we're just dumbfounded that someone would buy a used home five miles closer in, when they could buy a new home, it's the same school district, and it's just five minutes further out, and I think that's really starting to change.
And so we're focused on that group of customers. We're never gonna be able to compete with infill and closer in locations unless someone is working remotely and just willing to make that trade-off at that point. But there's a substantial amount of volume in and around, where location is the only thing that we should be discussing at that point. You literally wanna live on that street versus inside that school district, and that's really how we're thinking about it. The second thing 'cause it was asked, this doesn't change our, for us, this doesn't change our particular, the way we buy land as it relates to where we wanna be. We have an extensive market research department that everyone's aware of, that tells us which sub-markets can effectively compete with the used home market.
We don't go way far out like some of our competitors. We try to stay connected to the general MSA, so people are truly making that trade-off. And that's what we've been doing, frankly, for the last seven years. So that, that doesn't change for us as it relates to where we're looking to buy land.
I mean, at the end of the day, if you think about how most home buying experiences start, you know, whatever online app you use, you know, you draw your box around it, and then a whole bunch of homes pop up, right? So typically, we are finding ourselves in that set. If people are looking at a certain price point, we're probably in that price point already if they're drawing the box, right? So as Phillippe said, we're not gonna be in some of the inner rings, but that's not the product we build, so we wouldn't be targeting that customer anyway. So we just wanna make sure that if we're coming up on your home search, that we're not eliminated for a reason for the sheer reason being that we're a home—a new home builder.
We wanna make sure that we stay in your competitive set, both from your own perspective as a home buyer or a future home buyer, and when you give your list to your broker, that they don't kick us out either. That's really the thesis behind it.
I think-
Got it.
You know what? Just to take a moment here. One thing that has set Meritage on the course of the success we've had over the last, you know, seven, eight years, was the cohesiveness of our strategy, right? Our strategy wasn't just sort of, "We're gonna go do this. We're gonna go do that." It was very cohesive as it related, "We're gonna focus on the first-time home buyer, and in focusing on the first-time home buyer, we're gonna reimagine our product portfolio, we're gonna reimagine our operational model, and we're gonna reimagine our sales and marketing strategy to support us delivering great value to that customer." And then cascading down, you know, we're gonna make sure we're driving the right value in our business from a financial perspective and growth perspective to get where we need to go.
That's what we're trying to share with our investors today, is that it's not just one thing, right? It's not just, "Hey, let's just augment this piece of our business." There's this cohesiveness between carrying homes later in cycle and being a 60-day carrying, doing a 60-day, making sure your product is turnkey and move-in ready, and then leveraging a sales pathway that gives you the greatest success to deliver that product, and then cascading that down into operational decisions, financial decisions, that will drive the value and the growth that we're trying to achieve from here. And we really believe by doing this in this cohesive way, it gives us the greatest opportunity to take market share, right?
Not just take market share from the new home builders that some people say we compete with today, but take market share from the used home market that we typically compete with, and will be relevant over time. Our goal is to stay in there, and that gives us the best opportunity to achieve the results we're talking about.
Got it. Very, very interesting. We touched on this a little bit earlier, but I'm still seeing a lot of questions to this effect, so I figure with five or 10 minutes left, maybe we'll just kind of throw it out there again. The crux of it, you know, Surveyor Capital, Island C-III, asking similar questions: With this change in strategy here, how you know, does this change how much risk you are taking in the business across cycle? Would you react differently in a market downturn with this strategy versus your prior spec strategy? And coming at it from the perspective of, you know, we are 15 years into this cycle, 10-15 years, I guess, so, you know, if there is a downturn on the horizon, how would you react, and would it be any different than previously?
Yeah, so how do I think about risk in our business? Obviously, first is our balance sheet. And, you know, as we think about this, laying this thing into our business, you know, are we taking on more balance sheet risk? Yeah, we're gonna have more WIP. But we also think we're gonna have faster turns. So we don't feel like, with this strategy, we're gonna put our balance sheet in any worse of a situation than we were before. We believe that by doing this strategy, we're gonna be able to achieve a similar cost structure and cycle times, maybe even get better costs and better cycle times, which will allow us to effectively make sure we're managing the balance sheet risk. The second is land.
Does this mean that we're gonna start doing things differently with land than we've done before? The answer is no, we're not gonna start buying bigger deals with more development risks. We already buy big deals with development risks. We've gotten really good at that. We're not gonna start taking on more risky land. Are we gonna go further out? No, we're not gonna go further out. So I don't feel like this is gonna change the way we're buying land. We've tried to make this point both before this strategy and now today, but not all spec builders are created equal. And so some people believe that when you carry more specs and more inventory, you're increasing the risk of your business. We disagree with that, because our operating model, there is no difference between a spec and anything else we do.
We're always going to build specs based on the volume in the market. So if the volume slows, we'll adjust our spec inventory appropriately. But when all you do is sell specs, there's no delta between, we don't see risk to having specs versus not, and we believe specs will allow us to navigate the downturn more effectively, especially when the used home market. Not downturn, sorry, but whatever inflection we're experiencing, be able to effectively compete with in a bigger buyer pool than before. So that's how I think about risk. Hilla may have some other components of it, but that would be my response.
I totally agree. In the last down cycle, we ended up with a large amount of inventory on book that was very difficult to sell because it had a lot of customization. That's not where this strategy is. There is no customization. It's the same home that we were gonna start. Maybe we started and ended up with it on our books a little longer than we intended, but the price is gonna be the same, and the risk profile is much, much lower. Our strategy is looking for a month's supply of inventory on hand. So if the sales pace is pulling back because there's a negative event in the market, then we will start fewer homes to always kind of re-trigger to have the right number of homes.
We're not gonna have this big spec inventory, and then people come, and they want to do a to-be-built, and all of a sudden, we're growing the book even more. So we think. We were talking about this a little bit before the call went on, Alan, but, if a strategy is not something that you lean, lean into when times are tough, it's probably the wrong strategy. It's really easy to make money when the market is on fire. It's do you believe in what you're doing when it's tougher, is it still the right strategy? So I think it's really important that you believe in what you're doing in tough times and not tough times, and we think that this is the right path.
Competing with resale where the bulk of the market lives and embracing the broker community, which sells almost all of the homes in America, is probably the right path for us.
Right. Great. So question, which you kind of touched on again, but I'll ask it directly: How much capital is needed to fund growth beyond what would occur organically through your reinvested cash flow? So you mentioned, you know, having more WIP on the balance sheet, but you just did a debt deal recently. You increased some of your liquidity. Is this kind of in, you know, in the back of your minds, this strategy shift with- associated with, bumping up that liquidity target, or are you kind of at the point now where this can kind of fund whatever evolution is, is likely to occur?
Yeah, so we'll dig in a little bit more. This is my free pitch for the next call on June 12th. So please be sure to log in to that one. Wow, I'm like a salesperson now.
There you go.
So please be sure to log in to that one. But, yes, the very short answer is, you know, obviously, this debt deal didn't come out of the blue. We knew that we were gonna be doing a debt transaction. We have a maturity in 2025. So everything, all the guidance that we've already provided, with our $2 billion-$2.5 billion minimum threshold for the next couple of years in land acquisition and development, already considered the fact that we were gonna be doing a debt transaction. We obviously knew we were gonna do one. And also, our commentary about higher use of off-balance sheet financing also contemplated that. So the $2 billion-$2.5 billion is on book. There's obviously gonna be a component that's off book.
So we've run the math in our longer-term planning, and we've been living with the strategy internally for about two years now. So we knew this was coming up, even though we're just sharing it externally now. So we're very comfortable that we're not gonna compromise anything on our balance sheet. Our liquidity and our net debt to cap and all of the other metrics that we watch very closely, both because we think it's a risk mitigation strategy and because we're investment grade, and we want to keep that rating. All of that has already been contemplated in both alignment with the new strategy and the new debt component.
And also, just to be clear, the new capital allocation strategy, too, you know, the dividend-
Correct.
that happened a few months ago, as well as-
Absolutely.
repurchased, so that's all contemplated-
Absolutely.
in this. Sure.
I think that just sends the clearest signal around our confidence in the cash flow that our current operating model is generating and our belief in this strategy that the governors are in place, right? We know—we've told you what we think our net debt to cap ratio, what we're comfortable doing there. We've given general guidance on what our liquidity position needs to be. We announced our capital allocation strategy, which includes both share repurchases and a dividend. We told everybody how much land we're gonna buy to feed our growth. So that tells you how confident we are in our free cash flow to kind of do all that and grow the business from here, which we're setting the stage to do in this, in this conversation.
I think we're probably-
Great
out of time.
Yeah, we're at the 90-minute mark.
Oh, wow.
Yeah.
Yeah. Fast.
Any-
Faster than I thought. So thank everybody for being here. I appreciate it. I know some of this was people weren't sure what we were just here to share, but, you know, we felt it was really important. I get a lot of questions. Hilla gets a lot of questions about what it is that Meritage does other than just produce these financial results, and what is it behind the scenes that, you know, are really creating that. And with our prior strategy, there's a deep understanding of it, but this new strategy is really critical for us to kind of get to where we want to go next. We have substantial scale at this point, and we want to leverage that scale to grow from here and continue to produce really, really strong performance metrics.
So I just want to thank Alan for hosting this. I really, really appreciate it. I want to thank all of you for being here and joining the call. I'm looking forward to seeing all of you on the next one, and your continued interest in Meritage Homes. So please register on our Investor Relations website to attend the second part of our Investor Day webcast call series, which will take place on June 12th at 10:00 A.M. Pacific Time, and we will be discussing our next phase of long-term operational financial targets, as well as land finding, and financing, and capital allocation. So thank you so much, Alan, and we hope everyone has a great day.
Thanks, guys. Appreciate it.
Thank you.