Tailwinds in the housing market, including limited resale inventory, and continued demand strength contributed to fiscal third quarter results for Toll Brothers that significantly outperformed analyst expectations.

The home builder delivered a third-quarter record $3.73 profits per share on net income of $414.8 million, a 77% increase compared with the third quarter of 2022.

“Our third-quarter performance reflects a market for new homes that continues to benefit from historically low levels of resale inventory, favorable long-term demographic trends, and the persistent underproduction of homes for well over a decade,” says chairman and CEO Douglas Yearley. “In addition, our strategy of increasing our supply of spec homes in recent quarters has contributed to our success.”

The builder delivered home sales revenues of $2.7 billion in the quarter, a 19% year-over-year improvement. Contracted homes in the quarter increased 77% year over year to 2,245 in the third quarter. During the Toll Brothers earnings call, Yearley highlighted how demand remained strong in the quarter, which ended July 31, relative to the second quarter, a positive tailwind for the company given the historical strength of the spring selling season.

“Demand was stronger than normal in our third quarter compared to the second, with contracts down only 4% sequentially, compared to the long-term average of [a sequential decrease of] 16%,” Yearley said on the call. “Running almost flat from Q2 to Q3 is very encouraging, particularly with rates higher in Q3 than in Q2.”

On a per community basis, Toll Brothers sold at a pace of 2.2 homes per month, a significant improvement compared with 1.3 homes per month in the third quarter of 2022. The pace was down slightly from 2.3 homes per month per community in the second quarter. Yearley said the company saw particular strength in demand in the Mountain and South regions, both areas where Toll Brothers tends to have lower average prices.

The home builder reported a cancellation as a percentage of backlog of 3.2% in the third quarter, a sequential improvement from 3.9% in the second quarter. Cancellations as a percentage of signed contracts improved to 9.8%. Yearley said the builder’s low cancellation rate can be attributed to “significant up-front down payments” made by buyers as well as “the emotional attachment” formed during the personalization of homes. The cancellation rate also benefited from the high share of all-cash buyers, 25%, for Toll Brothers in the quarter.

Yearley said rising rates and the shortage of existing homes is a tailwind for new-home builders, particularly for larger, “well-capitalized” home builders that can build at lower costs, can take advantage of spec building, and can buy down mortgage rates for prospective home buyers.

“Our strategy of increasing our supply of spec homes, which we implemented several quarters ago, has helped us meet demand while also helping to improve our cycle times,” Yearley said. “Our spec homes represented approximately 40% of our closings in the third quarter, and we expect that to continue in the near term. Specs were 28% of deliveries in the third quarter.”

Toll Brothers’ backlog value was $7.9 billion at the end of the third quarter, down 30% compared with the third quarter of 2022. Homes in backlog totaled 7,295, a 32% decrease on a year-over-year basis.

“While rising rates remain a challenge, they further cement the lock-in effect that has kept resale inventory at historically low levels,” Yearley said. “With our deep and well-located land holdings, industry-leading brand, healthy backlog, more efficient operations, and balanced spec strategy, we are well positioned to capitalize on continued solid demand for new homes.”

Land Update

The builder ended the third quarter with approximately 70,200 lots owned and optioned. Approximately 50%, or 35,200, of the lots were owned. The company spent approximately $322 million land to purchase approximately 2,600 lots in the third quarter.

“This land position provides us with sufficient land needed for growth in 2024 and beyond,” Yearley said. “It allows us to continue to be selective and disciplined in our approach to buying land.”