**How D.R. Horton Bounced Back from Mortgage Rate Shock**
**Reducing Profit Margins to Attract Buyers**
Last year, the U.S. housing market experienced a sharp slowdown caused by a mortgage rate shock. Homebuyers became hesitant, fearing that they were buying at the peak of the market. Some even decided to back out of their contracts, leaving their earnest money behind. D.R. Horton, the nation’s largest publicly traded homebuilder, saw its cancellation rate spike from 16% in Q1 2022 to 32% in Q3 2022. It seemed like builders were in for a bumpy ride.
However, in June 2023, homebuilder stocks, including D.R. Horton and Lennar, reached new all-time highs as new home sales experienced a rapid resurgence. D.R. Horton’s cancellation rate also dropped to 18% in Q2 2023, showing a significant improvement. To understand how builders managed to exceed expectations in 2023, Fortune interviewed D.R. Horton’s CEO David Auld.
**Enticing Buyers Back Into the Market**
When the market started to decline, builders like D.R. Horton recognized the need to take action to entice buyers back. One of the strategies they adopted was reducing their profit margins, which had reached record levels during the housing boom. This allowed them to offer incentives that would attract buyers. For some builders, this meant offering aggressive rate buydowns, lowering buyers’ mortgage rates below 5%. In other cases, it required cutting prices by 5% to 10%, and even more in fast-correcting markets like Austin, where D.R. Horton is the largest builder. In some communities, home prices were slashed by over 15%.
**Improved Affordability and Lack of Inventory**
Entering 2023, the adjustments made by builders to improve affordability, combined with the lack of inventory in the resale/existing homes market, put single-family builders in a favorable position. D.R. Horton’s earnings reflect the success of these strategies. In Q2 2023, the company reported a 0.3% decrease in revenues compared to the same period in 2022. However, its net income dropped by 34%, indicating that affordability improvements, such as mortgage rate buydowns, had eaten into profits but contributed to increased sales. Despite the mortgage rate shock, D.R. Horton managed to climb up from No. 124 on the Fortune 500 list in 2022 to its highest-ever ranking of No. 120 in 2023.
**Q&A with D.R. Horton’s CEO David Auld**
Fortune conducted a Q&A with D.R. Horton’s CEO, David Auld, to gain further insights into how builders were able to corner the market. Auld, who has led the Arlington, Texas-based builder since 2014, has successfully navigated the company through various market challenges, including the post-Great Financial Crisis era, the COVID-19 recession, and the mortgage rate shock of 2022. Below are some highlights from the interview.
**Q: What contributed to the sales improvement in spring and how did D.R. Horton bring buyers back into the market?**
Despite higher mortgage rates and inflationary pressures, fundamental housing demand remained solid. Net sales orders for D.R. Horton improved during the second fiscal quarter due to normal seasonal factors and the use of incentives and pricing adjustments to adapt to changing market conditions. D.R. Horton typically experiences a roughly 50% increase in net sales orders from December to March. However, this year saw a better than normal seasonality, with a 73% sequential increase in net sales orders driven by the existing high demand versus limited supply. The introduction of increased incentives and adjusted base pricing of homes, along with interest rate buydowns, played key roles in attracting buyers.
**Q: In what types of communities or housing markets did D.R. Horton cut house prices in the past year, and how significant were those price cuts?**
Price adjustments were made by D.R. Horton’s local market operators based on specific market conditions and demand. The magnitude of price cuts varied across the company’s operating footprint, which spans 110 markets and 33 states. Generally speaking, pricing held up better in Florida communities. In the second quarter of fiscal 2023, the average sales price on closings was $378,800, a 6% decrease from the peak of $403,700 in the fourth quarter of fiscal 2022.
**Q: With the sales improvement, do you anticipate a reduction in buydowns or incentives in the near future?**
If the market continues to improve, D.R. Horton expects the opportunity to reduce incentives and gradually increase the base prices of its homes. This decision will be made on a community-by-community basis, taking into account local market conditions.
**Q: Did the expansion of profit margins during the pandemic housing boom allow builders like D.R. Horton to weather the mortgage rate shock?**
D.R. Horton agrees that expanding profit margins during the housing boom played a crucial role in enabling builders to reduce those margins later and adjust to the market. Despite a decline in gross margins due to significant rate increases in the second half of 2022, D.R. Horton’s margins still surpass its historical norm of 20%. The company’s home sales gross margin for the March quarter was 21.6%, and the projected margin for the June quarter is in the range of 21% to 22%. With historically low homebuilding SG&A costs and a strong mid-teens consolidated pre-tax margin, D.R. Horton was able to navigate the mortgage rate shock successfully.
**Q: How underbuilt do you believe the country is, and how does it compare to the analysis conducted by John Burns Research and Consulting?**
D.R. Horton’s CEO, David Auld, firmly believes that the housing market is still extremely undersupplied, both in terms of new and existing homes. He attributes this to development and construction capacity constraints in the industry. While it’s challenging to determine the exact degree of underbuilding, there is a growing consensus that the lack of housing supply will persist for years to come.
**Q: Did D.R. Horton witness a decrease in its build-for-rent business, similar to the decline observed by institutional investors?**
D.R. Horton continues to see strong interest from buyers in purchasing its multi-family rental projects and single-family rental communities. The company has also been able to sell rental communities to investors at a steady pace. As D.R. Horton scales its rental businesses, it is well-positioned to become the largest provider of rental communities for institutional investors seeking to reduce costs and increase efficiency in their portfolio acquisitions and management.
**Q: What percentage of D.R. Horton’s business is build-to-rent (BTR) as of Q2 2023, and how do you foresee this figure changing in the next five years?**
As of March 31, 2023,