Good morning, and welcome to the Taylor Morrison's Q4 2021 earnings conference call. My name is Gemma, and I'll be the operator today. Currently, all participants are in listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. As a reminder, this conference call is being recorded. I'd now like to introduce Mackenzie Aron, Vice President of Investor Relations. Please go ahead. Thank you.
Thank you and good morning. Before we get started, let me remind you that today's call, including the question and answer session, includes forward-looking statements that are subject to the safe harbor statement for forward-looking information that you will find in today's earnings release, which is available on the Investor Relations portion of our website at www.taylormorrison.com. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the release and in our filings with the SEC, and we do not undertake any obligation to update our forward-looking statements. In addition, we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in the release. Now, let me turn the call over to Sheryl.
Thank you, Mackenzie, and good morning, everyone. I am pleased to also be joined today by Lou Steffens, our new Chief Financial Officer, and Erik Heuser, our Chief Corporate Operations Officer. Lou officially steps into the CFO role January 1 after several years spearheading our transformational M&A strategy and integration execution. In his nearly 15 years with the company, Lou also held a number of regional and area president roles, and I am thrilled to be kicking off 2022 with him in this new capacity. Erik Heuser leads our strategic direction and oversees our land investments as well as our sales, marketing, and research teams. He joins us this morning to provide an update on our strategic partnerships with a focus on our build-to-rent business.
Before we dive in, I want to begin by acknowledging the extraordinary efforts of our home building and financial services team members throughout 2021, and especially in the fourth quarter. Their dedication and resiliency allowed us to end the year on a high note to deliver record-breaking results for our organization while serving our home buyers with an uncompromising commitment to construction quality and customer service despite the severe supply chain disruptions felt across the industry. Our customer-centric approach is key to our long-term success, and I believe has become even more differentiated in this challenging operating environment as we recently earned the coveted distinction of America's Most Trusted Home Builder for the seventh consecutive year. With our highest trust index score yet, this special recognition is a testament to our tremendous team members across the organization.
Let me review just some of the other highlights of the past year. In 2021, we increased our home closings by 9% to 13,699 homes, expanded our home closings revenue by 22% to nearly $7.2 billion, and improved our home closings gross margin by 370 basis points to 20.3%. We also realized meaningful cost leverage and benefited from the strong performance in our financial services business. As a result, our pre-tax margin improved by over 600 basis points, and we grew diluted earnings per share by 176%, each to new company highs. These strong results were achieved even with the unpredictable labor and material constraints that added significant complexity, extended construction timelines, and pressured costs throughout the year.
While some anticipated fourth-quarter closings and community openings were delayed because of these challenges, we are well positioned heading into 2022 to realize another year of significant growth in revenue and profitability as we continue to navigate these supply headwinds and benefit from our strategic focus on operational and capital efficiencies. This year, we expect to deliver between 14,000-15,000 homes at a home closings gross margin of at least 23.5%. This strength in margin outlook implies more than 300 basis points of year-over-year improvement and nearly 700 basis points over the last two years. Combined with our focus on optimizing our balance sheet and cash flows through landlighter investment and disciplined capital allocation, we also now expect to generate a new company-high return on equity in the mid-20% range.
As I have shared before, since reaching the critical inflection point in our integration of William Lyon Homes last year, the largest and most transformative of our six acquisitions since 2013, this phase of our strategic journey is focused entirely on capturing the many advantages of our enhanced scale and portfolio diversification that has transformed our ability to generate long-term value. From an operational perspective, while we have made significant progress in rolling out enhanced processes, we still have meaningful opportunity ahead to further enhance gross margins and improve asset efficiency. For example, we rationalized our floor plans in 2021 and are targeting additional reductions this year even as we open more communities. We are also eliminating option variation within the plans we build, which is even more beneficial to our construction efficiencies.
In 2021, our option library was reduced by more than 30% and will benefit further with the introduction of new national design specifications in the coming quarters. This strategic simplification allows us to streamline production and leverage our supplier relationships while ensuring we are offering only the most profitable and consumer desired plans. These efforts are supported by the growing share of our starts under our new curated option program kn`own as Canvas, which represented approximately 15% of our second half net sales and will steadily ramp higher throughout 2022. In fact, approximately 70% of our existing communities now offer Canvas, as will all new community openings going forward. With a simplified design process and faster cycle times, this program is driving greater production efficiency, improved profitability, and a better customer experience.
This focus on operational performance is matched by our focus on capital efficiency to drive greater cash flows. This includes strengthening our balance sheet and executing on new capital efficient land financing tools. After increasing the control percentage of our land portfolio by approximately 700 basis points to 38% last year, we now expect to grow our controlled share to approximately 45% by the end of 2022 as the new land financing vehicles that we established last year with Barings partners have accelerated our land-light balance sheet strategy. These cost-effective arrangements improve our ability to finance new land investments, reduce the amount of inventory held on our balance sheet, minimize long-term risk, and meaningfully improve expected returns.
As Erik will discuss, I am pleased to share that we expect to add additional financing capacity specific to build-to-rent projects that will enable us to cost effectively scale this growing segment of our business. From a demand perspective during the fourth quarter, we continued to benefit from favorable trends across each of our consumer groups and geographies. Strength was most notable within our move-up segment, which experienced year-over-year growth in both net orders and absorption pace, and represented slightly more than half of our total sales versus 44% a year earlier. Our 55-plus active lifestyle segment also continued to enjoy strong momentum. Thus far into the new year, consumer engagement across our portfolio has remained healthy, and our monthly sales pace has been consistent with the 3.2 pace experienced in the fourth quarter.
While this is down from 2020 to more sustainable levels, underlying demand is strong at both ends of the buyer spectrum, evolving consumer needs and preferences, migration trends, and limited availability of new and resale supply. However, given the significant tightness in the supply chain, we have remained disciplined in our sales strategy during the fourth quarter, and similarly raised prices by the 23% increase in our average net order price. By prioritizing [inaudible] , we successfully increased new starts per community by 7% year-over-year to 3.4 during the quarter and more than doubled our inventory of homes to 2.8 homes at the end of 2020. Only a handful of those homes were completed.
In today's supply-constrained market, this disciplined approach is providing greater visibility into our cost, improved efficiencies, and a better customer experience by releasing the homes for sale as they progress through the building cycle. Before I turn the call over, I want to spend a moment discussing our buyers' financial position and affordability considerations. As I share every quarter, one way we gauge affordability is by tracking the interest rate qualification buffer of our home buyers financed by Taylor Morrison Home Funding, which had a capture rate of 82% in the fourth quarter. We test the strength of these buyers by determining the maximum allowable interest rate they could have qualified for after considering compensating factors versus their actual interest rate. For our conventional borrowers, which accounted for 84% of fourth quarter mortgage closings, this spread was stable at roughly 700 basis points.
For our government, FHA, and VA borrowers, the spread compressed slightly on a sequential basis but remained healthy at 400 basis points. Different credit profiles with an average credit score of 752 and debt to income. Even more meaningfully, we estimated our customers in backlog could absorb before adjusting their loan terms. However, as you would expect, first-time home buyers have experienced slightly more affordability compression than our overall portfolio. Backlog is secured by substantial deposits at nearly 8.5% and more than $53,000 per unit on average. Collectively, these favorable trends supported the low average cancellation rates of 8.2% in the fourth quarter and a company low 6.6% in 2021.
Nevertheless, we are mindful of the significant movement in home prices and interest rates most recently and have taken proactive steps in our product design and spec inventory choices to ensure continued affordability, particularly in our entry-level communities. Lastly, before turning the call over to Erik, I want to highlight that we recently were recognized as the only home builder on Bloomberg's Gender-Equality Index for the fourth consecutive year for our long-held dedication to supporting diversity at all levels of our organization. This commitment to equality and transparency was recently strengthened further when we welcomed Christopher Yip to our board of directors, making the majority of our board diverse. We expect his significant experience in real estate technology to complement our focus on digital innovation.
Now, Erik will update us on our expanding build-to-rent operations, which is well on its way to becoming a meaningful and accretive portion of our overall business.
Thanks, Sheryl, and good morning, everyone. Since first announcing our entry into the build-to-rent arena in 2019 by way of a strategic relationship with our brand partner, Christopher Todd Communities, the long-term opportunity to serve both the renter-by-choice demographic and those impacted by rising home prices has only strengthened further. This business enables us to leverage our core production home development and construction to deliver innovative rental communities that we believe fill a void in the market. Unlike many other single-family rental offerings, our gated villa-style communities offer residents well-appointed amenities, social programming, and generally one- to two-bedroom single-story homes that are equipped with smart technology, pet-friendly features, and private backyards.
The average size of these communities is approximately 175 homes with an average rental rate of $1,700 per month for a typical 1,000 sq ft average unit, making them a compelling, affordable option for many prospective customers. In addition to the demand opportunity, these communities, which generally offer two floor plans, provide new ways to capitalize on streamlined construction processes. This supports accelerated cycle times with roughly 20 starts targeted per community per month. We also expect to garner benefits associated with organically growing cost-effective customer leads that will eventually benefit our for-sale business. As we continue to scale this segment, our priority has been to develop an efficient operating playbook and capital infrastructure to support return accretive growth.
Over the last two years, we have strategically expanded our market penetration and established a robust land pipeline that will fuel accelerating community growth in the coming years. We now have an active BTR presence in nine of our 19 markets of operation, with a handful of additional markets being evaluated for entry opportunities in 2022. While each of these markets are at a different stage of scaling, we have approved approximately 20 land deals that represent a portfolio of over 4,000 controlled lots. With an additional 20-25 deals planned for 2022, we expect to roughly double our controlled lot count by the end of the year. Once land is controlled and entitled, the horizontal and vertical construction process requires roughly two years before a community is ready to begin leasing and an additional year for stabilization and prospective disposition.
With our first community in Phoenix having recently begun leasing, we expect to evaluate exit strategies once it has reached our stabilization expectations later this year and are targeting an asset sale by year-end. Based on the timing of other projects under development, we expect to have several additional communities fully leased and ready for disposition in 2023, followed by strong growth in 2024 and beyond. With an extremely favorable investment environment for such yield-based horizontal apartment communities, we expect exit optionality to be high, with buyers ranging from financial partners to private equity, family offices, and others. Given the production efficiencies, no need for commission expenses, expected margins are modestly accretive to our traditional business, while levered returns are targeted to exceed 30% given the ability to finance the projects in a capital-efficient manner.
As Sheryl noted, we continue to progress the expansion of our land financing arrangements and expect to complete a vehicle targeted specifically to BTR projects in the near future. Before the benefits of contemplated leverage, we expect to dedicate 40% of the capital to such a venture and look forward to sharing more details in subsequent quarters. Lastly, it is also worth sharing that we intend to further leverage our BTR strength in the traditional single-family rental sector by developing and building rental homes and full communities targeted for disposition to SFR investors. In fact, we have recently approved our first bulk SFR project. This is yet another channel to maximize our operational scale, capitalize on market demand for rental assets, and enhance our long-term returns. With that, I will turn the call to Lou to discuss the company's financial review and outlook.
Thanks, Erik, and good morning, everyone. I'm excited for the opportunity to speak to you all today and look forward to getting to know you in this new role.
I will provide an overview of our strong fourth quarter earnings results and our detailed financial guidance for the first quarter and full year. To begin, we generated fourth quarter net income of $273 million or $2.19 per diluted share, which was up 204% year-over-year. On a pre-tax basis, our income margin equals 13.7%, up 610 basis points from the prior year. Turning to our operations, we delivered 4,283 homes during the quarter at an average selling price of $558,000, which drove a 61% year-over-year increase in our home closing revenue to $2.4 billion. Homes closed were slightly below our prior guidance due to extended construction cycle times.
As we navigate these supply constraints, our teams continue to be diligent and creative in finding solutions and most importantly, delivering high quality homes to our customers. This includes implementing enhanced scheduling processes, streamlining operations, and simplifying production through plan and option rationalization, and expanding and leveraging our strong trade and vendor relationships. While we are hopeful these strategies will help stabilize construction schedules as we move through the year, we're not projecting any change in supply chain conditions in our guidance. We currently expect to deliver between 2,600 and 2,900 closed homes in the first quarter and between 14,000 and 15,000 closed homes for the full year. Given favorable pricing trends and ongoing market strength, we expect the average sales price of our closed homes in 2022 to be at least $600,000 versus $524,000 in 2021.
This strong price growth is expected to drive a meaningful improvement in our home closing revenue for the year. From a gross margin perspective, our team's discipline focused on managing costs and optimizing our production processes has allowed us to achieve a significant improvement in our profitability. We have also benefited from the realization of acquisition synergies in line or better than expectations since we closed on William Lyon Homes in early 2020 across each of our markets. The 330 basis point year-over-year improvement in our fourth quarter home closing gross margin to 21.6%. Following this strength, we expect to generate a home closing gross margin for the full year. We now expect to deliver a home closing gross margin of at least 23.5% in 2022.
This would be up from 20.3% in 2021 and is stronger than our prior guidance provided in October of at least 22%, given further visibility into the strength of our backlog of over 9,100 sold homes. These homes reflect a number of favorable trends, including strong pricing power, acquisition synergies, the ongoing implementation of operational enhancements, improved lumber costs, and normalization of to-be-built homes. SG&A as a percentage of home closing revenue was 7.8% in the fourth quarter, down 180 basis points year- over- year. In 2022, we expect our SG&A to be in the high 8% range. This would represent meaningful leverage over 9.3% in 2021, given strong top line growth, disciplined cost management, and the early benefits of our virtual sales tools.
It is worth noting that these tools contributed to a 30 basis point improvement in external broker commissions in 2021, and we anticipate our commission expense will continue to decline as we expand the reach of our digital capabilities, including the use of both spec and to-be-built homes to nearly all of our communities. Turning now to our land portfolio, we ended the year with a robust pipeline of approximately 77,000 owned and controlled home building lots, which represented 5.6 years of total supply. This attractive land portfolio will support community count growth as we move through 2022 and into 2023. However, given supply chain constraints, extended land development timelines are expected to delay some of our community openings. We expect to end the first quarter with approximately 310-315 communities as closeouts outpace new openings.
Sequential growth each subsequent quarter is expected to bring ending community count to around 350 by the end of the year. Based on our existing land pipeline and current development timelines, we still expect substantial growth in 2023. I want to point out that going forward, we will provide a guide to ending community count rather than average, which is more consistent with how we manage the business and better reflects the selling and development environment. Before leaving the topic of community count, it is worth noting that one of the ways in which we're driving improved returns is by targeting multi-outlet, self-developed communities. Because of this shift, our approved land deals in 2021 had nearly 25% more lots than the trailing three-year average, yet lower expected durations due to a significant number of them having more than one outlet per project.
Because of these efficiencies, these communities drive greater margins and overhead synergies by allowing us to better leverage our field personnel and fixed costs and compete more effectively in the land market. Lastly, I will provide a brief overview of our capital position and allocation priorities. In 2021, we made significant progress in strengthening our balance sheet and executing on our new asset lighter land investment strategies. During the year, we invested $2 billion in land acquisition and development to support our future growth, repurchased 9.9 million shares outstanding for $281 million, and deleveraged our balance sheet by nearly 500 basis points to a net debt to capital ratio of 34.1%.
In 2022, we expect another strong year of cash flow generation and are targeting home building land acquisition and development of approximately $2.3 billion-$2.4 billion this year. We also expect to further reduce our net debt to capital ratio to the mid-20% range by year-end, and we'll continue to be opportunistic in returning excess capital to shareholders via share repurchases. These actions, combined with our strong earnings outlook, is expected to drive a return on equity to a new company high in the mid-20% range this year. In closing, I want to thank our teams for all their hard work in 2021. I'm excited about all we have planned in 2022 and look forward to updating you on our progress again next quarter. With that, let's open the call to your questions. Operator, please provide our participants with instructions.
Thank you very much. If you would like to ask a question, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two. We have our first question from Carl Reichardt of BTIG. Carl, your line is now open. Please go ahead with your question. Thank you.
Thanks. Good morning, everybody. Thank you for the time today and all the details. Hey, Sheryl. I wanted to ask, just on mix and going forward mix with the move-up side being 51% of total orders. As you look at the community count openings, including the sort of multi-outlet thing that we're all talking about in 2022 and even beyond that, how do you see your mix adjusting over time? Do you expect it to go lower end? Is there any kind of regional alteration that you're expecting over the next year or two?
Good question, Carl. A couple of things. When I look at the mix of the quarter, you saw that we were slightly slanted more than we have been to that move up, first- and second-time move-up in active adult. When I look at the new communities, Carl, that will be coming on board over the next many quarters, I think you'll see a little bit more pickup in the first-time buyer. I think as we look over time, we'll see our average sales price, you know, moderate a bit as a result of that. When I look at it regionally, probably not significant shifts. I mean, Florida will continue to prioritize the active adults, certainly the Sarasota and Naples area.
When we look at the, you know, Carolinas, Georgia, I think you'll see a much greater penetration in the first-time buyer, as you will in our California business. One of the most recent shifts in the California business is actually the complement of the active adult positions that we've added. They have, as we've expanded the Esplanade brand across the country, performed quite well.
Great. Thanks, Sheryl. My follow-up is on the improvement on the Canvas. I guess that I'm trying to think about the right way to ask this. If you look at what your ultimate goal on, say, build cycle time is from the improvements that you're making to your efficiencies, and you compare it to what your cycle time was before the pandemic. With the pandemic sort of muddying the waters here, what kind of improvement in, let's say, build time do you expect ultimately to achieve from these initiatives? Thanks.
Thank you, Carl. You know, it's interesting because we don't have a tremendous amount of data yet on the Canvas, even though we saw about 13%-14% of our sales in 2021. What I would tell you the early read is, and interesting, Carl, I haven't gone back and compared it against pre-pandemic, but if I look at it in real time, compared to the cycle times we're seeing in what I would call our more typical design center builds, we've seen a benefit of about 20- days in cycle time on our Canvas packages. Even though the entire, you know, kind of portfolio is a little out of whack across, you know, in Taylor Morrison and in the industry, given the dynamics we have out in the marketplace, we are absolutely seeing a benefit in the Canvas build.
I would expect that as that matures through the organization, and obviously we'll see a considerable ramp up in 2022, we should be able to build on that. As we get to a more normalized environment again, I would expect that we should retain at least a couple of week cycle time enhancement.
Carl, this is Lou. Good morning. Just one thing to add to that.
Hey, Lou.
Another big area that we believe we're going to see significant benefits is the sale to start time frame with Canvas. That's another added benefit we'll see coming through the pipeline as we continue to roll that out.
Thanks, Lou. Thank you, Sheryl. Appreciate it.
Yeah, you bet. I just might even add one last comment to it, because Lou, you're so right. When we look at, you know, the fourth quarter and we look at some of the closings we lost, we generally lost them in our active adult business. Specifically, Florida is where we saw the greatest shift. When you compare Canvas or even our normal design center appointments, you know, as we look across the portfolio, our options, I know we've chatted about this in the past, but our options in a market like Naples and Sarasota, which is generally all our Esplanade brand or a high majority, that's about 2x the company average. When you take that level of complexity out of the build with the Canvas packages, once again, I think it's just tremendous opportunity for us.
Great. Thank you.
Thank you.
Thanks, Carl.
Our next registered question comes from Matthew Bouley of Barclays. Matthew, please go ahead with your question.
Hey, good morning. This is Ashley Kim on for Matt today. Congrats on the nice results here. If I could just kind of ask, you know, what's given you incremental confidence to kind of put out that 23.5; 23.5 gross margin, you know, versus that 22% + that you kind of alluded to prior? You know, was that simply kind of just conservatism until you built up more of that backlog or anything in the pricing or cost outlook that has contributed to that?
You want to start with that?
Yeah, sure. Ashley, good morning. In terms of our confidence, I would say having over 9,100 sold homes in our backlog, we have strong visibility to the future margin profile. In that, our teams have, I believe, built in the correct amount of contingency to get us through with cost increases we're seeing today. Combine that with the specs that we have under production, which we've increased significantly year-over-year, you know, strong visibility to where we think today pricing on those is going to end up being. We have overall, between our specs and our backlog, quite a large portion of our total year's closings, some visibility on today.
Yeah. To your point, Lou, compared to last year, like you said, we doubled our spec inventory. Given that those have gotten the true benefit of real pricing, we're in a very different position than we were last year. If you think about the 22% we shared last quarter, I mean, the backlog was in a different place. Lumber was moving. I mean, a lot of the units are secured for the year already.
Good. Thanks for that. Just on my second question, you know, appreciate that kind of extra color on affordability, given up top. If I could just kind of expand on that topic, have there been any, you know, changes in buyer preferences that you're seeing, any kind of lower square footages or less options in premium, in response to that stretching affordability?
Not yet, to be quite honest about it. You know, we've continued to see strength in our buyers, and their behaviors have not really moved. You know, as we discussed in the prepared remarks, you know, the favorable characteristics we've seen with our closed customers quarter after quarter just didn't meaningfully change in Q4. As I mentioned, we did see some compression with that first-time buyer and where we've seen probably a little bit more resistance, and probably a larger percentage of folks that pre-qualify and have challenges would be with that first-time buyer. Then when we looked at our entire backlog, you know, our conventional buyers mirror our closed buyers. Their credit scores are high, their DTI back-end ratios are almost right on top of our closed buyers, and they have very strong qualifying incomes.
We then went ahead and looked and said, "What would happen if rates move up, you know, to 4.5?" You know, honestly, their back ratios still stay very healthy under 40%. Even if we move rates up to 5.5%, they barely go over 40%. A little bit different with FHA buyers, as I mentioned. You know, their back-end ratios would move into the low 50s. No, generally, if there's been any push on kind of rates, it's really more backlog because those are the folks that, you know, maybe when they entered into a purchase agreement with us, rates may have been something around 3%, so watching that movement.
I think most notably is we've done a great deal of surveys with our shoppers to understand how they feel about the mortgage rate environment. We did a very similar survey back in 2018, and we started comparing the two. We've learned a few things. One, the percentage of shoppers that expect to pay cash is significantly higher, and that aligns with what we're seeing in our closings and our backlog. I mean, it's moved up. Our cash buyers have moved up more than 50%. The baseline question we asked our shoppers is, "Well, how would you feel if rates moved to 5%?" The most interesting stat is only 5% of the hundreds of shoppers that we surveyed said that they would stop looking at 5%.
That is much less than half of the response we got in 2018. They feel like they have a number of different strategies they can deploy, you know, larger down payments, a smaller offering, the type of loan. I think the most surprising stat was the high point of interest rates that would affect their search was very healthy until you got to 7%. I think what we have to remember is with the migration patterns we're seeing from California, New York, New Jersey, the optics on affordability is very, very different. When you look at what the average consumer today has in equity in their existing home, this is an advantage for the move-up buyer or active adult buyers.
I think we saw a stat yesterday that John Burns quoted that the average equity is $302,000 per household. When you can bring that to the table, it really helps you offset any increase in interest rates.
Yeah. I think as you said, Sheryl, in those high-cost cities, people are migrating. These homes are really cheap to them and from some of the places they're relocating.
Yeah, it's the local buyers, right?
Right.
I hope that helps, Ashley.
Yeah. All fair points there. I guess thanks for taking my questions, and I'll leave it there. Good luck.
Of course.
Thanks, Ashley.
Jay McCanless from Wedbush, you have the next question. Please go ahead.
Hey, good morning. Thanks for taking my questions. I guess the first question I had going to the build for rent, and thank you for all the detail there, but I was just wondering, at the end of the prepared comments, you guys talked about doing some bulk sales. Are the bulk sales going to be on balance sheet for Taylor Morrison, or is that going to be part of the Christopher Todd joint venture?
Good morning, Jay. Yeah, that's really a licensing agreement and kind of leveraging the brand that exists for Christopher Todd. Those will be on balance sheet. Those will be Taylor Morrison assets, and we'll be kind of in control of those disposition decisions.
For build-to-rent.
For build-to-rent. For sure.
Yeah. The SFR really won't be engaged with the build to rent process.
Correct. Yeah. I think, Jay, the right way to think about it is the way we're defining build to rent is really the Christopher Todd model, which is the horizontal apartments, kind of the one-platted amenitized communities. The single-family rental is just leveraging our core business to be able to produce homes that ultimately would be disposed of to SFR players in the space. That might look like individual homes, that might look like specs, that might look like dedicated communities, that might look like dedicated phases within our master plan. A lot of optionality that we're excited about exploring.
Okay. Yeah, that's what I was kind of getting to, is I didn't know if it was going to be a model where you just built an entire community and then sold it. It sounds like you guys are using it basically as kind of a tactical play more than anything else. I guess that's the best way to think about it. My next question is on the cancellation rate. 8% sounds great. Could you tell us what it was last year and where it was in the third quarter?
Yeah, sure. Jay, this is Lou. Last year, our fourth quarter, we were at 7.9%. You know, a lot of us would argue that that may be even too low at where we're at today. Our financial services team does such a great job of pre-qualifying our buyers, which makes it a lot easier for us that we don't have to worry about a ton of cancellations in our business. You know, you would almost argue we could take some more risks out there, but we're very proud of how low it is.
Yeah, that's great. Then just my last question. I think, and correct me on this, I think you said in the prepared comments that your average lot count inside the communities that you're putting under contract is up about 25%. I'm just wondering, you know, how far out are you having to go to get that extra 25%, or are you able to stay closer into town? I guess, you know, kind of thinking about how, you know, how much are you having to give up in terms of potential profit or anything like that to get the extra lots? Is it, are these still locations that are fairly close in to the metro, the core of the metro areas?
Yeah. Jay, I would suggest that, you know, we're still focused on core locations. I always look at the land opportunities in context of a portfolio. To the extent, you know, we need to expand 10%, into those areas to get exposure, I would say we're comfortable with that. By and large, we're focused on core locations. I wouldn't say that, you know, we're needing to do those sizes. Frankly, you know, in some cases it's a benefit because we have multiple outlets within those communities.
That's right. The only thing. Oh, I'm sorry, Lou. The only thing I was going to add is if you think about our active adult business, generally those are larger communities. As those come into the portfolio, they will have some effect on the overall size of each asset. That would be another strategy where you know that we have probably 3-5 positions within an active adult community.
Just lastly, Jay, I'd say that it's part of having the scale that we have. A lot of builders couldn't take down that large of project. You know, we're able to get into the core locations, as Eric said, and get the synergies of having more than one outlet. Many players just aren't willing to do that big a project.
Can't. Yeah.
Exactly.
Thank you.
The next question comes from Mike Rehaut of J.P. Morgan. Mike, please go ahead with your question.
Great. Thanks. Good morning, everyone.
Hey, Mike.
Good morning. I wanted to circle back to the gross margin guidance and obviously very encouraging on the full year raise. You know, in terms of cadence, I was just wondering, you know, you obviously laid out the 22% for the first quarter and the 23.5% for the full year. Just trying to get a sense, if possible, you know, in terms of the step up into the back half, and obviously it implies ending the year over the 23.5%. But should we be expecting kind of like more of a ratable increase over the next three quarters, you know, 2Q - 4Q?
Could we see another pretty significant step up in 2Q? The reason I'm asking that is obviously you have the 9,000+ homes in backlog at end of Q3. It would seem that, you know, with that type of visibility, you know, I kind of expect a notable increase in the second quarter off the bat.
Yeah, Mike, it's a great question. I'd say you're looking at it right. Q2, we had the favorable benefits of lumber reductions, so we'll see some fairly strong margins in Q2. As we continue to move through the year, we've been able to stay in front of, you know, cost increases going forward. Getting to where we expect to exit, the exit rate at the end of the year, you know, just based on the averages, you know, you're
We don't have visibility on Mike in the fourth quarter. It's probably the newest round of rate locks on the lumber because this next lock will really determine your fourth quarter deliveries. To Lou's point, absent that, they're just going to continue to see that ramp up.
Yep.
Makes sense. You know, I guess secondly, you know, one thing that, you know, the whole industry is going through right now or investors looking at the industry is trying to gauge over the next two or normalized gross margin could be because, you know, obviously you've had a massive amount of gross margin expansion. You know, earnings have doubled and tripled, and, you know, people are trying to triangulate, you know, what's normal. You know, for Taylor Morrison, you know, there's been a lot of structural change on top of, you know, the improving housing market and the stronger housing market and positive price cost.
I was hoping if you could give a little bit of insight in terms of when you're underwriting land deals today, what type of gross margin is part of that. And also, when you look back at gross margins that from 2015 - 2019, it averaged about 18%, where you're going through a lot of acquisition integration and so forth. I guess it's a sort of a two-parter. One, what would that 18% look like today with the improvement in cost structure post-acquisition integration? And secondly, from a what would the new base-
Mike, a couple of things. You know, obviously, we're not in a position yet to give margin, too. But you said it correctly. When you look in our kind of rearview mirror and you look at the margin profile we've seen for the last five, six years, Lou, we've really had a great deal of noise, you know, with purchase accounting and things like that. You know as well as I do kind of the long-term run rate of margin profiles in our industry for the last 20 years and kind of normalized times has been in the 20s. Do I think structurally it's going to be a little higher than that for the foreseeable future, given the supply-demand disconnect? I think so. Hard to nail that down. Anything else, and then we can talk a little bit about the underwriting.
I would say, Mike, you know, we're finally going to be the beneficiaries of all the hard work our teams have done on the acquisition front, from simplification to the various other synergies and the scale that we've achieved through this most recent M&A. On top of that, between AV and at fairly strong, you know, really good prices, so.
Great time.
I think we're really pleased where our lot position is today, and our 5.6 years of supply feels really good based on, you know, when those lots were secured and contracted.
Mike, I would add just from an underwriting lens 2004. I would tell you with full admission, the last couple of years have been really interesting. You need 10% lift in ASP to cover it, and we've experienced that. You know, I think we would say that, you know, we've been able to hold our land residual ratios. You know, we're performing well relative to our underwriting, and we're underwriting at current market prices. Where we've been more conservative really is on the paces because that has felt a little bit of a unique environment as we think about the last couple of years.
We've actually engaged in a pretty robust third-party study that's helped us understand really what is a normalization expectation for each one of our markets as we think about historic paces, as we think about land coming online, as you think about our positions. Spent a lot of time on that, a lot of time on scenarios and, you know, how do we think about some different things playing out relative to our underwriting, so.
It's hard to ignore, Erik, the kind of generally 20%-25% reduction in community count in most markets, right?
Right.
As those come online, we're gonna expect to see paces, you know, moderate. We're really trying to make sure we're ahead of that, Mike.
Great. Thanks so much.
Thank you.
Thanks.
Our next question on the line comes from Alan Ratner of Zelman & Associates. Please go ahead, Alan.
Hey, good morning. Thanks for taking my questions.
Thank you, Alan.
First one, and nice to hear you on the call, Lou. Welcome aboard on the public-facing side. You know, just on the spec count, the doubling that you referenced there, obviously that's, you know, those are homes under construction and you mentioned the completed number remains very low. Can you talk a little bit about your strategy with those specs in terms of when you're actually releasing those for sale? Are you holding them back until completion or close to completion? Just curious, you know, because we're hearing similar numbers and similar strategies from other builders as far as kind of holding specs back.
I'm just curious if you've given any thought to the competitive landscape as the year unfolds, as you look at specs on the ground today versus potentially, you know, available for sale at some point in the future.
Yeah, Alan, maybe I'll take the first shot at that. I would say, you know, our markets, each market based on, you know, the supply chain environment, probably releases them at a slightly different time frame depending on when they have better visibility on the costs. So one division may release them more at, you know, after slab, another may be closer to frame or close to drywall. So it probably varies a little bit across the portfolio. But more importantly, as they feel they have strong visibility on, one, the cycle time and two, the cost structure.
Yeah, I think that's right. To Lou's point, Alan, I mean, it is pretty varied, but I would tell you that there's an overarching company view and working with our divisions that there's a lot of inventory being built, and we want to make sure that, you know, we get it out to market as quick as we can, and where it really makes sense. The supply environment is different in each of our markets. There are some where there's not a lot of inventory under construction across, you know, the new home builders, and there's some where it's pretty heavy. There's a lot of considerations in that. We feel really good. We're not carrying any completed inventory to speak of.
I don't think it's 20-25 units across the portfolio today, which I would tell you is much leaner than we'd like. We're not going to let these things age, but if we can get them to at least frame drops or lumber drops, it gives us strong visibility on the most significant cost component of the house.
Yeah. As it relates to our backlog, it's interesting. From 2020, we've seen a 66% increase in the number of our backlog homes that were sold at spec. You're starting to see it really come through the portfolio at this point in time as we've continued to increase our spec.
Yeah.
Yeah.
Probably the most significant piece that's worth mentioning, Alan, is you know with that pivot you know if you think about last year we had very few specs. Everything was a to-be-built. You saw our sales rates. In some of our markets where we've really moved up our spec inventory you know we've slowed down sales. That's a little bit of what you saw in Q4. Honestly what you'll see in Q1 is we let those things at least get slabs in the ground where we've pivoted from really holding back any to-be-built lots at the more affordable level specifically to specs. That's it. It's both. It's impacting our sales pace as well as anything.
Yeah, that's kind of what I was getting at, Sheryl, so thank you for that.
Yep.
It sounds like a lot of builders are doing the same thing, talking about, you know, first quarter orders, maybe not seeing that typical seasonal lift that you otherwise would, given kind of the timing of, you know, aging those specs a little bit and getting further along in the construction process.
Exactly.
Second question, you, on the mortgage side, and thank you for all of the information on the surveys, et cetera. I'm curious, you know, now that the move-up piece of your business has grown as a piece of the pie, at least for the time being. You know, when you look at your either buyers or prospective buyers, and, you know, I think the biggest difference now perhaps versus earlier on in the cycle when rates were hopping around is, you know, the vast majority of home buyers at this point have refinanced at a much lower mortgage rate. You know, if you look at the overall universe of mortgage holders, you know, 70% are locked in below a 4% rate.
While affordability might still be attractive, you know, just thinking about turnover, there is that risk that a buyer is going to be less willing or perhaps, you know, it's a tougher pill to swallow to give up a low rate when the newer rate is going to be above that. Have you know, looked at that at all or surveyed that at all in terms of the willingness for the buyer to give up that low rate if the newer rate is well above kind of where they're locked in at?
Yeah. That's the survey that I mentioned, Alan. We've actually spent a great deal of time understanding kind of our shoppers' views on what's motivating them to relocate. We obviously saw a different level of motivations back right after the pandemic started than what we're seeing today. You're right, people have very low interest rates, but you can't forget that $300,000 on average. Generally, when we think about the reasons they're moving, they have a whole different set of motivations today. You know, when you look at the move-up buyer, they need additional you know flex spaces, added bedroom counts, moving closer to grandchildren. There's all kinds of motivations. Honestly, we are seeing even in our move-up buyers, the first inventory to go is generally the largest. It's been quite interesting.
Now, the motivations on the first-time buyer are a little bit different, and that's where we're seeing, like I said, some compression. We're really making sure that the specifications on those houses is really targeted to market, so it doesn't take people out of the buying opportunity. Interestingly enough, when you look at what they're locked in today, it's really being offset by the amount of equity they have in their home.
Got it. All right. I appreciate that. It'll be interesting to watch unfold here. Thanks a lot.
Sure. Thank you.
Truman Patterson from Wolfe Research. You have the next question. Please go ahead.
This is actually Paul Przybylski on. Cheryl, I guess just, you know, touching, you mentioned that you really hadn't seen any trade-down in square footage yet, and you just said that the move-up buyer is trending towards the higher square footages. As you look across your spectrum of floor plans, where exactly does the consumer stand? i.e., how much room do they have to trade down before you would have to go back to the drawing board? And then do your lower square footage floor plans carry the same margins as the higher ones?
Yeah, they do. Let me. I'll go in reverse order there, Paul. Generally, it's square footage is not what's shifting the margin. A lot of it has to do with, you know, when the land was acquired. So, you know, if I look holistically at the portfolio, we are seeing some reduction with the added specs in square footage because what we're putting out to market is generally our specs tend to be the more affordable plans. You know, we can't run from what we've seen happen in both pricing and rate movement. We've done a great deal of testing to look at the buyers that bought, you know, 12 months ago and look at those same plans today and at, you know, potentially 4% interest rates. Of course, there's real movement.
The interesting thing is when we test that on our backlog, their capability to absorb that without really any significant movement in their back-end ratio. Some of it's being overcome because they've got higher down payments. Their financial picture has improved over the last year. Once again, and I hate to be redundant, but, when you look across our backlog and the shoppers that are coming in today, they're not yet in a position making those trade-offs on the move-up. We are seeing a slight compression. Even with that compression, even our first-time buyers are in a position that, you know, the rates are moving them to the higher end of, let's say, you know, back-end ratios, but still well within the range of what they can afford to do.
What I have found most interesting is when we kind of parse apart our backlog, the average loan amount for our government FHA buyers is actually higher than our conventional buyers because one of the tools they do have is the ability to put a higher, you know, is to be able to do a, you know, 3% down payment. That's why we're keeping such a close watch on that first-time buyer because their incomes aren't moving at the level that the combined rate and price appreciation has.
Okay. I guess, you know, as rates have moved higher this year, have you seen any conservatism enter the land market from either you or your peers?
You know, as Erik mentioned, and Erik, why don't you speak to it? We have been very discerning in our acquisition strategy.
Yeah. I think it all comes around to scenarios, right? You know, what if home prices take a step backward? Was that due to our underwriting? What does that mean relative to the affordability of that land? What does it mean to our metrics? Yeah, I can tell you it's a conversation as part of every land that we underwrite. It really comes by way of the scenarios.
We're certainly not seeing sellers.
Thank you. Appreciate it.
Not yet.
Okay.
There's usually a 6- 9 month drag on land.
For sure.
I think, as I mentioned earlier, we're in a good position where we don't have to chase a lot of land because we do have a strong, you know, land bank in front of us. We're not chasing those deals that look to us a little bit too high in cost.
We're walking from them.
Yep.
Yeah.
Yeah. We are seeing some transactions that, you know, we wouldn't participate in.
Yeah. That's okay.
All right. Appreciate it. Thank you.
Thank you.
Thank you, Paul.
Our next registered question comes from Mike Dahl of RBC Capital. Mike, your line is now open.
Hey, this is Ryan Frank on for Mike. Thanks for taking my question.
Of course.
In the interest of time, I'm just gonna squeeze one quick one in here. There's been a lot of talk about the mix shift over the past couple of years. I was just wondering, is there any notable margin difference between your entry level, your move-up, and your active adult products?
You know, I'd say they're surprisingly fairly consistent across all of those. Some of it may be, you know, on affordable stuff that we bought from the acquisitions at a great rate. Overall, the
Yeah
Despite the mix, they're relatively consistent.
The only probably real difference we may see, Lou, if you agree, is on the active adult. Once again, if we look at what they're spending on lot premiums and what they're spending on options, I mean, our lot premiums basically doubled last year. Most of that came through the active adult business. Our options, once again, I think on average may have been $70,000 on the portfolio, including active adult. The adult position is two times that. It is certainly helping the margin profile of that consumer group.
I think as you said, Sheryl, the strength we've been seeing there has been, you know, really amazing this year.
Yeah. We're not even into the selling season yet.
Right.
Yeah.
Got it. Helpful. I guess you did mention kind of the acquisitions again. Is there any notable difference between kind of your legacy Taylor Morrison land and the AV and the William Lyon land? Again, on the margin front.
Yeah, I would say we've been very pleased again at, you know, how those deals have performed in terms of the acquisitions. You know, it doesn't take away. I think our teams also over the last several years have acquired some amazing pieces. Overall in the blend, they seem to be very close to or on the same today as when we first, you know, did the acquisitions. Obviously, we had to work through integration, and so we started out of the gates with a little bit lower margins. As we've integrated and worked in some of those simplification items, you know, we're starting to see-
Made a difference.
A lot of compression between the two.
You know, we just showed our board in this last board meeting kind of a chart that I think said it all, but it really took kind of our legacy divisions that have never done an acquisition and looked at their margin profile. Then we layered on top the divisions that had a combined business and then the standalone. What became very clear is everything we've been sharing for the last few years, about two years you started to really see pull-through, and by three years, it's all the same, was true. When I look back to our AV, our divisions that were formed through the AV acquisition, those margins are consistent with the standalone divisions. They generally sell.
When you look at the movement in William Lyon Homes, we're not quite there yet, but the year-over-year movement's been tremendous and give us another 12 months. By the third year, where it's a full pull-through, and you'll see alignment across the portfolio.
Yeah. Adding to that, we're seeing some of the divisions from acquisitions are having the highest margins across the company.
Yeah
I have a particular level of pride related to that.
I can land.
Our teams have done an awesome job. Yeah.
Yeah. Mm-hmm.
Awesome. Thank you very much.
Our next question comes from Kenneth Zener. Go ahead with your question.
Good morning, everybody.
Morning.
Morning.
You mentioned starts. Really appreciate that. Can you talk to the starts and orders relationship that we saw in the second half of 2021 as we enter? Second, Lou, a little housekeeping, I guess, but do you have, you know, what it's figured at? I think it was about 1.07 last year, the WIP value, as well as what-
Sorry. Maybe tell me if I'm missing any of these, Ken, but maybe starting off with starts. We finished our WIP inventory ended about $1.3 billion at the end of 2021, and we're really pleased. Our total units under construction were up 30% year-over-year. You know, we had obviously a tough finish closings, but our teams have done a great job positioning us even better for this year with 30% more units under construction to achieve our closings this year. As of the end of January, we had about 75% of our total units under construction for this year's closing. You know, in today's supply chain environment, nothing's easy, but it's definitely trying to set ourselves up for better success this year.
In the back half, Lou, I think sales ran ahead of starts. You saw that we tried to show, you know, that kind of turned on its head in Q1.
Yep.
As we're trying to get more specs in the ground. Last year with the backlog we had of to-be builds, that just wasn't an option for us. You're going to see those align. We'd like to get starts ahead of sales really for the next quarter or so. Because when you look at cycle times, we need that. I mean, we used to be able to start houses through May and June for the year. If I were to take you pre-2021, that's just not the case in this environment.
Yeah. This year, you know, plan to have significant majority of everything started by the end of April.
Our final question today comes from Alex Barron of Housing Research Center. Please go ahead with your question, Alex. Your line is open.
Good morning. Just to jump on that last question, you gave 15,000 starts for the year. What was it for the last quarter? Along those lines, you know, how many total homes under construction do you guys have? Because you mentioned that your specs have gone up significantly or I think-
With your first question, we started almost 3,400 starts in Q4. I don't know if I heard you correctly, but we started 16,000 homes in 2021. I think you may have said 15, but I could have heard you wrong. Total units under construction. Of that, we have almost two-
Wasn't it, like, under 1,000 like 985 or something?
Yeah, we had like 2020.
Okay, great. That's helpful. The other question I had was, you guys have mentioned this initiative to move towards design palettes and simplify the number of SKUs that you guys are employing on specs, you know, where you and people just pick out one of them, or is that something you're giving people on their jobs as well, where they get to pick, you know, which one is it or is it both?
Yeah, it's a little bit of both, Alex. When we started, you may recall that we talked about kind of the five different packages and the range of prices, trying to keep the spend generally similar to what they would have spent in the design center, but making the process just simpler for the buyer. We started out our rollout last year with inventory homes to make sure that they were aligned with market. Then we moved into model homes to make sure the consumer could see what those look like, and it just helped them visually kinda let it all come together. Then we started doing to-be builds with buyers, especially at the more affordable or I would say the first-time move-up price point.
Now as I look at it's really definitely all of our specs, and I would say a large percentage of our move-up, where they will have the choice to do a Canvas package, or they will be able to go into a, you know, a typical one day. We've got a new program, which is a one-day design center appointment. You know, when I look at the demographics of who so far, it is very skewed to what we call baby maybes. So these are folks that are just starting out a new family or kind of a home at last. They've been aspiring to get a new home, and that is the large majority. We're starting to see a little bit more take up in the active adult.
Once again, that will primarily grow because they really do enjoy the opportunity to specify to their wishes.
Maybe just adding to that, Alex, we transitioned to a national spec program near the end of the year for both to-be-built and specs. Just as a couple examples, you know, the SKU reductions, appliances were down over 80% from what we had offered before. Similarly, over 80% in paint. Over 30%. Trying to continue to improve, you know, our possibilities in terms of achieving our closing goals based on ensuring we have more availability of the products that we're putting into our homes.
That simplification carries over into the SFR and BTR conversations too.
For sure. That's where, I mean, it's Canvas minus.
Okay. Well, that's a great answer, and it's very, very good in terms of the way you guys have approached it. My final question has to do with your share count guidance. 124 million doesn't seem to imply a lot of share buybacks. I mean, you guys kind of engaged more in that this year. Is that kind of implying you're going to step back from share buybacks or you're just not really dialed into any significant activity at this point, but you're still open to doing some?
Yeah, I would say we're always looking at that as an option on our capital allocation priority. First, we want to invest in the business. You know, secondly, we want to continue to strengthen our balance sheet as time goes on. Lastly, with excess capital, we definitely will look at, you know, share repurchases.
We would never include that in our forward-looking guidance. I'd update you on a quarterly basis.
Okay. Awesome. All right. Well, great job and good luck for this year. Thanks.
Thanks, Alex.
Thank you. Thank you all for joining us today. Look forward to updating you at the end of the first quarter.
Thank you very much. Your lines. Have a good rest of your day.