Gross margins fall
In the fourth quarter of 2015, Toll Brothers’ (TOL) gross margins, excluding interest and write-downs, fell to 22.3% compared to 26.8% a year ago. On a sequential basis, gross margins rose from 19.8% in the third quarter.
City Living is Toll’s luxury rental arm
While other builders are guiding for lower gross margins going forward, Toll Brothers expects to see further expansion of gross margins and average selling prices in fiscal 2016. This expansion would be driven by its California business, more revenues from City Living, and solid demand that seems to be picking up. This is driven by real estate price appreciation that’s outstripping cost inflation and land costs.
Foreign demand is a key driver of rising margins in cosmopolitan cities like New York. Toll Brothers is also increasing its rental business in these areas.
Could labor costs rise in the future?
The open question for builders is how long they can continue to increase or maintain this level of gross margins. Unlike most other commodities that are falling, lumber is holding up reasonably well. The other issue is that land prices are rising. The bigger problem for builders is skilled labor, as that’s hard to find. We are hearing anecdotal evidence of wage pressure in the construction sector, as well as other parts of the economy.
One of the side effects of the housing bust has been the exodus of skilled construction workers from the sector. After the bust, housing starts fell off a cliff, and they’ve been mired below the previous lows ever since. Many construction workers ended up finding jobs in trucking and the energy sector.
Most market participants expect home price appreciation to cool in the upcoming year. Builders such as Toll Brothers (TOL), Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), and CalAtlantic (CAA) won’t be able to raise margins simply by raising prices. That said, as long as inventory remains tight, prices should still be supported.
For a broad exposure to the homebuilding sector, investors can explore the S&P SPDR Homebuilder ETF (XHB).