Taylor Morrison Home Corporation

Good morning and welcome to the Taylor Morrison Supported 2021 Earnings Conference Call. My name is Gemma and I'll be the operator today. Currently, all participants are in this session. 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 Aram, 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 Cheryl.

Thank you, Mackenzie, and good morning, everyone. I am pleased to also be joined today by Lou Steffens, our new Chief Financial Officer, and Eric Kueser, our Chief Corporate Operations Officer. Lou officially stepped into the CFO role January 1st 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. Eric 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 to 15,000 homes at a home closings gross margin of at least 23.5%. This strengthened 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 lamb-lighter 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 known 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 controlled 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 Vardy Partners have accelerated our land lighter 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 Eric 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 the record-breaking activity experienced in the first quarter of 2020 to more sustainable levels, We believe underlying demand is strong and supported by demographics 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 to align net orders with construction capacity. As a result, Approximately 75% of our communities metered sales activity during the fourth quarter and a similar share raised base pricing, which helped drive a 23% increase in our average net order price. By prioritizing production ahead of sales and carefully balancing price and pace at the community level, 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 spec homes to six spec homes per community at quarter end from just 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 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. Said differently, because our buyers generally have strong credit profiles with an average credit score of 752 and debt-to-income ratio of 36% in the fourth quarter, they have many levers to pull to offset higher rates or prices if necessary. Even more meaningfully, we estimated our customers and backlog could absorb similar increase in interest rates before adjusting their loan terms. However, as you would expect, first-time homebuyers have experienced slightly more affordability compression than our overall portfolio. In addition, our backlog is secured by substantial deposits at nearly 8.5% and more than $53,000 per unit on average. Collectively, These favorable trends supported below 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 Eric, 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 boards diverse. We expect his significant experience in real estate technology to complement our focus on digital innovation. Now, Eric 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, Cheryl, 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 builder strengths of land acquisition, 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 square foot 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 to 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 dispositions. 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, and overall market strength, 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 Cheryl 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. And 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, Eric, 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 equaled 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're 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 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 disciplined focus 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. as well as robust pricing power across each of our markets. This execution is evident in 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 of approximately 22% in the first quarter. And 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 in the mix of our spec versus to-be-built homes. SG&A has a percentage of home closing revenue of 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 our online reservation system for 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 account growth as we move through 22 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 to 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. And 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 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 to $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 will 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. And if you would like to ask a question, please press star followed by 1 on your telephone keypad. And if you change your mind, please press star followed by 2. We have our first question from Carl 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, Cheryl. 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 22 and even beyond that, how do you see your mix adjusting over time? Do you expect it to go lower end? And then is there any kind of a regional alteration that you're expecting over the next year or two?

Good question, Carl. A couple 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, second time move up in active adults. 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 moderate a bit as a result of that. When I look at 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 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. And they have, as we've expanded the Esplanade brand across the country, they have continued. They have performed quite well.

Great. Thanks, Cheryl. And then my follow-up is on the improvement on the Canvas. And I guess I'm trying to think about the right way to ask this. So 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, so 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. No, 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. So 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 that And obviously we'll see a considerable ramp up in 2022. We should be able to build on that. And then as we get to a more normalized environment again, I would expect that we should retain at least a couple of weeks cycle time enhancement.

And Carl, this is Lou. Good morning. Just one thing to add to that. Another big area that we believe we're going to see significant benefits is the sale to start timeframe 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, Cheryl. Appreciate it.

Yeah, you bet. And I just might even add one last comment to it because, Lou, you're so right. And 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. But 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 two times the company average. So when you take that level of complexity out of the build – on with the Canvas packages. Once again, I think it's just a tremendous opportunity for us.

Great. Thank you.

Thank you. Thanks, Carol.

Our next registered question comes from Matthew Bowley 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, what's given you incremental confidence to kind of put out that 23.5 gross margin versus that 22% plus that you kind of alluded to prior? 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?

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. And in that, our teams, I believe, have built in the correct amount of contingency to get us through with cost increases we're seeing today. And then 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. So we have overall between our specs and our backlog, quite a large portion of our total year's closings, some visibility on today.

Yeah, and to your point, Lou, compared to last year, like you said, we doubled our spec inventory. And 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 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.

Thanks for that. And then 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. And 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 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? And, you know, honestly, their back ratios still stay very healthy under 40%. And even if we move rates up to 5.5%, they barely go over 40%. A little bit different with FHA buyers, as I mentioned. Their back end ratios would move into the low 50s. But no, generally, if there's been any push on kind of rate, it's really more backlogged because those are the folks that maybe when they entered into a purchase agreement with us, rates may have been something around 3%. So watching that movement But I think most notably is we've done a great deal of surveys with our shoppers to understand how they feel about the moving 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, how would you feel if rates moved to 5%? And the most interesting stat is only 5% of the hundreds of shoppers that we've 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. And 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. And then 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. So when you can bring that to the table, it really helps you offset any increase in interest rates.

I think as you said, Cheryl, in those high-cost cities people are migrating, these homes are really cheap to them from some of the places they're relocating.

Yeah, it's the local buyers, right?

Right.

So I hope that helps, Ashley.

Yeah, all fair points there. And I guess thanks for taking my questions, and I'll leave it there. Good luck.

Of course. Thank you.

Jay McCandless from Wedbush. You have the next question. Please go ahead.

Hey, good morning. Thanks for taking my questions. So I guess the first question I had going to the build for rent Thank you for 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?

No. Morning, Jay. Yeah, that's really a licensing agreement and kind of leveraging the brand that exists for Christopher Todd. But those will be on balance sheet. Those will be Taylor Morrison assets and will be kind of in control of those disposition decisions.

For built-to-rent.

For built-to-rent.

The SFR really won't be engaged with the built-to-rent process.

Correct, yeah. Yeah, I think, Jay, the right way to think about it is the way we're defining built-to-rent is really the Christopher Todd model, which is the horizontal apartments, kind of the one-platted amenitized communities. And the single-family rental is just leveraging our core business to be able to produce homes that ultimately we'd be disposed of to SFR players in the space. And 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. So 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 It's going to be a model where you just built an entire community and then sold it, but 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%. So, you know, a lot of us would argue that that may be even too low where we're at today. Our financial services team does such a great job of pre-qualling 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. But, 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. And 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%. And 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 much are you having to give up in terms of potential profit or anything like that to get the extra lots? Or are these still locations that are fairly close to the core of the metro areas?

Yeah, Jay, I would suggest that we're still focused on core locations. I always look at the land opportunities in context of a portfolio. So to the extent we need to expand 10% into those areas to get exposure, I would say we're comfortable with that. But by and large, we're focused on core locations. I wouldn't say that we're needing to do those size deals to reach out. I would say it's a function of the deals that are available to us. And frankly, in some cases, it's a benefit because we have multiple outlets within those communities.

The only thing I was going to add is if you think about our active adult business, we Generally, those are larger communities, so as those come into the portfolio, they will have some effect on the overall size of each asset, but that would be another strategy where you know that we have probably three to five positions within an active adult community.

And 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 larger project, so we're able to get into the core locations, as Eric said, and get the synergies of having more than one outlet, but many players just aren't willing to do that bigger project.

And can't. Yeah. Exactly. Good point.

Sounds great. Thanks for taking my questions.

Thank you.

The next question comes from Mike Reher of JP Morgan. Mike, please go ahead with your question.

Great. Thanks. Good morning, everyone. First, I wanted to just, 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 and a half, but should we be expecting kind of like more of a ratable increase over the next three quarters, you know, two Q to four Q, or can we see another pretty, you know, pretty significant step up in, And the reason I'm asking that is obviously you have the 99,000-plus homes in backlog. That all else equal would probably get you somewhere to the second or third quarter. So it would seem that, you know, with that type of visibility, you know, I'm kind of thinking you'd see a pretty 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. And then as we continue to move through the year, we've been able to stay in front of cost increases going forward. But getting to where we expect to exit, the exit rate at the end of the year, just based on the averages, you're probably in the low to mid-24s.

I mean, the one thing we don't have visibility on, Mike, in the fourth quarter is probably the newest round of rate locks on the lumber, because this next lock will really determine your fourth quarter deliveries. But to Lou's point, absent that, they're just going to continue to see that ramp up.

Right. That 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 three years what a quote unquote 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 costs. You know, I was hoping if you could give a little bit of insight in terms of, you know, when you're underwriting land deals today, you know, what type of gross margin is part of that. And also, you know, when you look back at gross margins that you generated from 2015 to 2019, it averaged about 18%. And that was obviously a period where you're going through a lot of acquisition integration and so forth. I guess it's sort of a two-parter. One, what would that 18% look like today with the improvement in cost structure post acquisition integration? And secondly, you know, from a land underwriting standpoint, you know, what would the new baseline be, so to speak?

So, Mike, a couple things. You know, obviously we're not in a position yet to give margin guidance out beyond 2022, 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, what, five, six years, Lou, we've really had a great deal of noise, you know, with purchase accounting and things like that. So, you know, 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, so 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, 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 those most recent M&As. On top of that, between AV and line, we acquired a lot of lots at fairly strong, you know, really good prices. So 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.

And Mike, I would add just from an underwriting lens perspective, look, I've been doing this since 2004. So I would tell you with full admission, the last couple of years have been really interesting. You know, with land, if it's gone up 30%, you need 10% lift in ASP to cover it, and we've experienced that. And so, 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 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. And so we 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. Cool.

It's hard to ignore, Eric, the kind of generally 20% to 25% reduction in community count in most markets, right? So as those come online, we're going to expect to see paces moderate. So we're really trying to make sure we're ahead of that, Mike.

Great. Thanks so much.

Thank you.

Our next question on the line comes from Alan Ratner of Zalman Associates. Please go ahead, Alan.

Hey, good morning. Thanks for taking my questions. So, first one, and nice to hear you on the call, Lou. Welcome aboard on the public-facing side. So, 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? And just curious, you know, because we're hearing similar numbers and similar strategies from other builders as far as kind of holding specs back. And 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 timeframe, 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 closer 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. And to Lee's point, Alan, I mean, it is pretty varied, but I would tell you that there's an overarching company view in 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 the new home builders, and there's some where it's pretty heavy. So 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.

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. And 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. So in some of our markets where we've really moved up our spec inventory, we've slowed down sales. That's a little bit of what you saw in Q4. And 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. So it's impacting our sales pace as well as anything.

Yeah, that's kind of what I was getting at, Cheryl. So thank you for that. And it sounds like a lot of builders are doing the same thing, talking about first quarter orders, maybe not seeing that typical seasonal lift that you otherwise would, given kind of the timing of aging those specs a little bit and getting further along in the construction process.

Exactly right.

Second question, on the mortgage side, and thank you for all of the information on the surveys, et cetera. I'm curious, now that the move-up piece of your business has grown as a piece of the pie, at least for the time being. When you look at your either buyers or prospective buyers, and I think the biggest difference now perhaps versus earlier on in the cycle when rates were hopping around is the vast majority of homebuyers at this point have refinanced at a much lower mortgage rate. And if you look at the overall universe of mortgage holders, 70% are locked in below a 4% rate. So 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. So have you, you know, looked at that at all, 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. And you're right, people have very low interest rates, but you can't forget that $300,000 on average. And 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, the house isn't, you know, exactly, they need additional, you know, flex spaces, added bedroom counts, moving closer to grandchildren. There's all kinds of motivations. But honestly, we are seeing, even in our move-up buyers, the first inventory to go is generally the largest. So 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. So 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. But 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 homes.

Got it. All right. I appreciate that. It'll be interesting to watch unfold here. Thanks a lot.

Sure. Thank you.

Chairman Patterson from Wolf Research, you have the next question. Please go ahead.

This is actually Paul Schabelsky on. Cheryl, I guess just touching, you mentioned that you really hadn't seen any trade down in square footage yet. You just said that the move-up buyer is trending towards the higher square footages. But 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. I'll go in reverse order there, Paul. Generally, square footage is not what's shifting the margin. A lot of it has to do with when the land was acquired. So 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, you know, potentially 4% interest rates. And, of course, there's real movement. The interesting thing is when we test that on our backlog, there are 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. So 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. But even with that compression, even our first-time buyers are in a position that the rates are moving them to the higher end of, let's say, 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. And 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. Okay. And then 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 Eric mentioned, we have been, and Eric, 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? So, you know, what if home prices take up that backward? What does that do to our underwriting? What does that mean relative to the affordability of that land? What does it mean to our metrics? So, yeah, I can tell you it's a conversation as part of every land that we underwrite, and it really comes by way of the scenarios. Thank you. Appreciate it. Not yet. There's usually a drag, a six- to nine-month drag on land. For sure.

And 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. So we're not chasing those deals that look to us a little bit too high in cost.

We're walking from, yeah.

And we are seeing some transactions that, you know, we wouldn't participate in.

Yeah.

All right. Appreciate it. Thank you.

Our next question comes from Mike Dahl of RBC Capital. Mike, your line is now open.

Hey, this is Ryan Frank from Mike. Thanks for taking my question. In the interest of time, I'm just going to squeeze one quick one in here. So there's been a lot of talk about the mixed shift over the past couple 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 on the portable stuff that we bought from the acquisitions at a great rate, but overall, 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 locked 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. And our active adult position is two times that. So it is certainly helping the margin profile of that consumer group.

I think, as you said, Cheryl, the strength we've been seeing there has been really amazing, Cheryl.

Yeah. We're not even into the selling season yet.

Got it. Helpful. And then I guess you did mention kind of the acquisitions again. So 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 how those deals have performed in terms of the acquisitions. But, you know, it doesn't take away. I think our teams also, over the last several years, have acquired some amazing pieces. So, overall, in the blend, they seem to be very close to around 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. But as we've integrated and worked in some of those simplification items, you know, we're starting to see 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. And then we layered on top the divisions that had a combined business and then the stand-alones. And what became very clear is everything we've been sharing for the last few years, about two years, you start to really see pull through. And by three years, it's all the same was true. So when I look back to our AV, our divisions that were formed through the AV acquisition, those margins are consistent with the standalone divisions, generally so. And when you look at the movement in William Lyon, we're not quite there yet, but the year-over-year movement's been tremendous and give us another 12 months. So by the third year, where it's a full pull-through, and you'll see alignment across the portfolio.

Yeah, and adding to that, we're seeing some of the divisions from acquisitions are having the highest margins across the company. So I have a particular level of pride related to that, but our team's just done an awesome job, yeah.

Yeah, mm-hmm.

Awesome. Thank you very much.

Thank you.

Our next question comes from of KeyBank. Please go ahead with your question.

Good morning, everybody.

Good morning.

If you could talk to, you know, you mentioned starts, really appreciate that.

Can you talk to the start and order relationship that we saw in the second half of 21 as we enter kind of the first half of 22? And second, a little housekeeping, I guess, but do you have, you know, what the WIP inventory closed this year out at? I think it was about 1.07 last year, the WIP inventory. value as well as community last year.

Sorry. So maybe, uh, tell me if I miss any of these, uh, Ken, but maybe starting off with starts, we finished the year with around 16,000 starts for the year. Our whip inventory ended about $1.3 billion at the end of 21. And we're really pleased our total units under construction. We're up 30% year over year. So, You know, we had obviously a tough finish, and we're a bit disappointed where we ended up in terms of 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 closings. So, 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.

And in the back half, Lou, I think sales ran ahead of starts. But you saw that we tried to show, you know, that kind of turned on its head in Q1 as we're trying to get more specs in the ground. Last year with the backlog we had of TB builds, that just wasn't an option for us. But you're going to see those align. We would 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-21, that's just not the case in this environment.

Yeah, this year, you know, plans have a significant majority of everything started by the end of April.

Really appreciate your operating comments. Thank you.

Thank you.

Our final question today comes from Alex Barron of Housing Research Center. Please go ahead with your question, Alex. Your line is open.

Yeah, thanks. Good morning. Just to jump on that last question, you gave 15,000 starts for the year. What was it for the last quarter? And along those lines, how many total homes under construction do you guys have? Because you mentioned that you're had gone up significantly, or I think doubled, but I wasn't sure you quantified how much you're talking about there.

Sure, Alex. Good morning. So with your first question, we started almost 3,400 starts in Q4. And I don't know if I heard you correctly, but we started 16,000 homes in 21. I think you may have said 15, but I could have heard you wrong. And then total units under construction at the end of 21 were close to 10,000. Of that, we have almost 2,000 of those were specs.

And wasn't it like under 1,000, like 985 or something?

Yeah, we had a little over 800 in 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. But is that a strategy that you guys are employing on specs? you know, where you're starting homes with these design palettes and people just pick out one of them? Or is that something you're giving people on dirt jobs as well, where they get to pick, you know, that? 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 kind of let it all come together. Then we started doing to-be-built with buyers, especially at the more affordable or I would say the first-time move-up price point. Now as I look at it, 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 typical one day. We've got a new program which is a one day design center appointment. When I look at the demographics of who is selecting the Canvas program so far, It is very skewed to what we call our demographic profiles of these 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. But once again, that will primarily be on specs with that consumer group because they really do enjoy the opportunity to specify their wishes.

And maybe just adding to that, Alex, we transitioned to a national spec program near the end of the year for both 2B build and specs. And just as a couple of examples, the SKU reductions, appliances were down over 80% from what we had offered before. Similarly, over 80% in paint, and then flooring selections down over 30%. So 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.

And that simplification carries over into the SFR and VTR conversations, too.

For sure. And that's where, I mean, it's Canvas.

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, 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. So is that kind of implying you're going to step back from share buybacks or you're just not really diving to any significant activity at this point, but you're still open to doing something?

Yeah, I would say we're always looking at that as an option on our capital allocation priorities. So first, we want to invest in the business. Secondly, we want to continue to strengthen our balance sheet as time goes on. And then lastly, with excess capital, we definitely will look at share repurchases.

But we would never include that in our forward-looking guidance that 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.