Gross margins are the basic profits from building individual homes
Analysts keep close tabs on a company’s gross margins, which are revenues less the cost of goods sold. This estimates the gross profit on building homes, but ignores other expenses like selling, general, and administrative costs, taxes, interest, and other corporate expenses. Major costs include land development, construction costs, materials, and labor. In the fourth quarter, KB Home’s gross margins increased 260 basis points year-over-year, to 18.3%. This is, however, a sequential decrease from the third quarter, where gross margins topped 19%.
Average selling prices continue to climb
Average selling prices for KB rose above $300,000 in the fourth quarter, an increase of 11% from the same quarter a year ago. Most of the other builders have noted larger increases in average selling prices. Average selling prices are a function of geographical exposure and average sizes. Luxury builders, such as Toll Brothers (TOL), can increase average selling prices by simply building bigger homes.
High average selling prices reflect the dearth of inventory we’ve seen caused by a lack of building since the housing bust and also restricted existing homes for sale. Many people who would like to sell are underwater on their mortgages (in other words, they owe more money than the home is worth) and can’t sell their home without permission from their lender for a short sale. Second, foreclosed inventory is being held off the market—especially in the judicial states, as judges invariably side with the borrower over the lender and generally make foreclosure as painful as possible for the lender.
For the builders, this means they have less competition with existing homes than they otherwise would, which allows them to raise prices without having to offer promotions and incentives. The days of high margins may be numbered, as we’re seeing bidding wars for skilled labor, and once builders can’t drive revenue growth simply by raising prices, they will increase deliveries.