Last January, Steve Hilton, CEO of Scottsdale, Ariz.–based Meritage Homes, told housing analysts that his company had made several changes to boost sales in this dismal housing market. The most evident change can be found in its products.
“Our roots are more in the move-up to luxury housing market,” Hilton says. “It’s very hard to get a non-conventional loan from a traditional bank—it takes a much larger down payment and there are appraisal issues, so there are very few of those buyers out there today. Most buyers are entry-level or first move-up. They’re not willing to pay for some of the things we were offering in the past. Price is extraordinarily important. People are much more value-conscious. We’ve had to adapt our product to offer the best price and value possible.”
To do that, Meritage made a strategic decision to shrink square footage. Since last summer, Meritage has introduced 52 new models in its markets in California, Arizona, Nevada, Colorado, Texas, and Florida. Its plans previously ranged from 1,200 to 4,500 square feet. Today they still start at 1,200 but have less architectural detailing and stop at 3,000 square feet.
“It was a pretty big shift, and we had to convince our leaders the market had shifted,” Hilton says. “We got buy-in from all of them and went out and started executing.”
While it might seem like Meritage is altering its business plan, COO Steve Davis says it’s actually returning to a time “when 1,500 to 2,000 square feet was the best seller. It wasn’t until 100 percent financing became available that people went for 3,000 square feet. Until that financing came in, this was our sweet spot.”
Taking on Foreclosures
All of Meritage’s new models are designed to pursue first-time and first move-up buyers and to compete head to head with resales and foreclosures. Like most builders, Meritage has found that competition to be merciless.
“We have a couple of employees who bought houses in Phoenix in 2005 and 2006,” Hilton says, by way of illustration. “One bought a $500,000 house. The same house sold on her street in foreclosure for $170,000. Another bought a $700,000 house and had a house on the same street sell in foreclosure for $350,000. We’re still building in those neighborhoods.”
While smaller, the new house plans are designed to respond to the features that today’s home buyers value including open gathering spaces and bedroom count, Davis says. By reducing or eliminating formal living and dining rooms and breakfast nooks and replacing them with country kitchens, “you started having more space you could utilize for bedrooms,” Davis says. “You could have four bedrooms in 1,700 square feet or six bedrooms in 2,600 square feet. The houses are much more functional. It used to be that you had to go to 3,000 square feet to get the extra bedrooms. Buyers commented favorably on that.”
To save money and increase efficiency, Meritage assigned the redesign of all the plans to one architect, Michael Woodley of Santa Ana, Calif.
“In the West—Arizona, California, and Nevada—the architectural preferences are very similar between the states,” Hilton says. “We could use a lot of similar product, as opposed to designing independent product like we did before. Now we can benchmark our costs between the three states. We can really understand our costs better. That will help us deliver a lower-priced home and a more profitable home for Meritage.”
In addition to the smaller square footage and streamlining the plans to make them more efficient to build, several factors have helped the company reduce its costs. Labor and material costs have come down by about a third, Hilton says, and land costs have dropped by as much as two-thirds from what they were during the peak of the housing boom. The result is the ability to lower prices by as much as 40 percent to 50 percent and still make a profit.
“For us, it’s pretty stunning,” Hilton says.
Since the new products are still very new, there aren’t volumes of sales data yet to show how the strategy will pay off, but early results are encouraging. In its Orlando, Fla., market, square footages were cut in 90 percent of its communities, and costs were cut by about a third. The average sales price was lowered by about 22 percent to roughly $200,000. In that market, 57 houses were sold in 2008’s fourth quarter, which is more than in previous quarters, Hilton says.
Davis says the company has had no pushback from its buyers on the smaller floor plans. “In most cases, you’re not talking to someone coming out of a 5,000-square-foot house,” he says. “They’re coming out of apartments. … The sales speak to that. In places where we’ve introduced it, we’re seeing sales improve.”
They’ve also been much more consistent across communities, Davis says, “versus one hot community.”
Mining The Data
An integral part of Meritage’s shift to smaller products was developing relevant data from which to design product that would appeal to the new target buyers. Phillipe Lord, head of Meritage’s research department, closely tracks foreclosure and resale transactions in each of its markets.
“We created a more comprehensive data platform to break down those transactions at a detailed level as they move through the market,” Lord says. “We can see, specifically to a community market area, what people are buying in the whole competitive set, not just new homes.”
The biggest surprise in the data, Lord says, was “how relevant the resale has become. In some markets, we’re seeing some of the lowest new-home permit levels in decades. The resale market is capturing north of 90 percent of the market. It’s usually more of a 70-30 split [between resale and new construction].”
In the Phoenix market alone, the resale volume is averaging over 5,000 transactions a month.
“That’s the encouraging thing for us,” Hilton says. “Five thousand buyers is a lot if you can figure out how to compete against that. Why buy used when you can buy new for a very comparable price?”