Homebuilders are paying for sales with margin: NVR gross margin falls to 18.3%, M/I to 20.9%, Pulte to 24.8%

Three of the biggest US homebuilders reported third-quarter results this week, and the pattern is the same in each: fewer homes sold, thinner margins and rising use of price cuts and mortgage rate buydowns. Realtor.com News summarized the trend on Friday. We went to the companies' own filings on SEC EDGAR for the figures it left out.

The number behind the number: gross margin

Net income fell at all three. The more useful line is gross margin, because it shows what the sales cost.

Sources: PulteGroup, NVR and M/I Homes filings. M/I's year-earlier margin is derived from its 10-Q, which reports a 300 basis point decline to 20.9%.

Margins fell by 140 basis points at Pulte, 270 at NVR and 300 at M/I. Each company gave a slightly different reason. NVR cited higher lot costs, pricing pressure from affordability and weak consumer sentiment, plus about $24.8 million of land-deposit impairments. Pulte's margin includes $26 million of land impairments, about 70 basis points. Pulte's 10-Q says its average selling price fell on product and geographic mix, "elevated sales incentives" and efforts to reduce spec inventory, and that it expects incentives to stay elevated.

Put in dollars, our estimate from the rounded figures is that NVR's homebuilding gross profit fell about 20%, to roughly $430 million from about $538 million, on revenue that fell 8% to $2.35 billion. The sales discount costs more than the revenue line suggests.

Backlog tells a different story than orders

NVR's backlog rose 10% in units to 10,121 homes, but only 4% in dollars, to $4.59 billion. Dividing one by the other, the average home in backlog is worth about $453,000, roughly 5% less than a year ago (our calculation). Builders are holding unit volume partly by lowering the price of what they sell. Pulte's backlog tells the same story in milder form: units up 4% and value up 3%.

M/I Homes went the other way. Its backlog fell 7% in units to 2,046 homes, and the average price in backlog slipped to $539,000 from $553,000.

Why rate buydowns are getting expensive

M/I Homes CEO Bob Schottenstein said on the company's call, as Realtor.com quoted, that buydowns remain the primary incentive but that "with rates rising during the quarter, the cost of such buydowns has increased, thereby impacting our margins." That is the squeeze: the higher the mortgage rate, the more a builder pays to cut a buyer's rate by the same amount.

Freddie Mac put the 30-year fixed rate at 7.32% on October 22, down from 7.40% the previous two weeks, according to its published history. A small decline, but still a rate that keeps buyers out.

Who it hits

Take an illustrative $450,000 new home with 20% down. At 7.32%, the principal-and-interest payment on the $360,000 loan is about $2,473 a month. A one-point buydown to 6.32% lowers it to about $2,233, or $240 a month. To get the same $240 from price alone, the builder would have to cut the price by roughly $43,700, or 9.7%. That is why builders prefer buydowns to headline price cuts: a buydown protects the posted price of the neighborhood, even though the margin hit is real.

• Someone closing in November: a buydown or closing-cost credit is negotiable now, and builders with spec homes to move are the most willing. Ask for the incentive in writing and compare it with a straight price cut on the same house.
• A framing, drywall or cabinet sub: builders under margin pressure push back on subcontractor bids. Expect requests to hold or cut prices on the next phase.
• A seller of a resale home: the competition is a new house with a below-market rate attached. Pulte's CEO said rising rates have made selling an existing home even harder.

The backdrop: NAHB builder confidence is at 29, with 43% of builders cutting prices in October. We covered the September housing-starts drop earlier this week. The ITB homebuilder ETF was at $90.74 in Friday trading, 20.1% below its February 13 closing peak, per Yahoo Finance data.

The balance sheets are not the problem: M/I reports no borrowings on its $900 million credit facility, and Pulte has $1.4 billion in cash and a 12% debt-to-capital ratio. The problem is price. Builders can protect volume or margin, and this quarter's filings show them choosing volume at a visible cost. More on rates at our 10-year Treasury chart.

Sources: PulteGroup, NVR and M/I Homes earnings releases and 10-Qs on SEC EDGAR; NAHB/Wells Fargo Housing Market Index; Freddie Mac; Realtor.com News. Payment figures are illustrative arithmetic, not offers. This is market information, not investment advice.