We put many of our specs on the market when they’re being framed, and on occasion — more than on occasion regularly, we may slow down construction as drywall is being hung so that the buyer has that opportunity to pick their flooring, pick their kitchen cabinets, pick their countertops, pick their Kohler plumbing fixtures, et cetera, et cetera. And that still offers the buyer the opportunity to go through the design studio process, have a comb that they feel is custom to their lifestyle, but it’s still a much quicker delivery than if they started fresh before we’d even pulled a building permit. So this strategy is now in its second full year, it is working, and it will continue to drive growth in the future.
Operator: Thank you. And our next question today comes from Alan Ratner with Zelman & Associates. Please go ahead.
Alan Ratner: Hey, guys. Good morning. Congrats on the great year.
Douglas Yearley: Thanks, Alan.
Alan Ratner: Doug, a couple questions. I know you’re still somewhat early on in the spec shift, but I’m curious if you can give a little bit of color in terms of how specs kind of just perform in comparison to bill to order. Obviously, margin is probably the main focal point. But do you see any differences in kind of how spec buyers behave when rates are volatile in either direction, either up or down, or any other kind of interesting observations you’ve kind of taken as you’ve grown that part of your business?
Douglas Yearley: Sure. So let me first start on the numbers. Our specs sell for about $200,000 less than build-to-order, and that’s because of two things. We generally don’t build a spec on the high-lot premium lots. We save the best lots for those clients who want to go build-to-order, because we know the build-to-order crowd, when they get into our design studio, they spend a lot more money. And so part of that $200,000 lower price is a more average lot premium and it’s less upgrades. We make sure the specs are fully curated with great finishes. We bring in nationally acclaimed designers that do the interior design of our model homes, to come up with great packages, but we don’t go wild and we don’t overdo it. And so naturally, that price is a couple of hundred thousand dollars lower.
We also tend to build more specs in less expensive communities because you have more buyers. The lower you go in price, the bigger the market you have. Generally, specs gross margin is about 250 basis points lower than build-to-order.
Martin Connor: Right now.
Douglas Yearley: At this moment in time.
Martin Connor: Right
Douglas Yearley: Now, we are encouraged that that spread is tightening a bit. But as part of our new business model, we’ve accepted that. We’re not disappointed by that at all. We’re happy with that because when you blend the build-to-order model and by the way, another stat that’s related to this, we are now at 26.5%, reflecting lot premium plus upgrades for the build-to-order client that used to be 21%. So those that go in build to order, they’re taking the best lots with the higher premiums, and they’re spending more money on both structural and finish upgrades. And therefore because, as we’ve talked about, our gross margin coming out of our design studios is up at 40%, the build-to-order business model is driving terrific margins.
We are happy to weigh into that to blend into that a spec margin that’s 2.5 points lower because the overall package, as you can see, is pretty darn good and we’re driving a nice high margin. So that — I hope that helped you, Alan, with the breakdown of the price point of the spec and the margin of the spec.
Alan Ratner: Yes, that’s all really helpful. Definitely gives us good insight into how that mix will unfold. So appreciate all the detail there. Second question I had is on the land side. I know there’s been a few questions on inventory turns and things like that. You guys are making great progress towards the 60% option goal. I’m curious if you have a goal or a target or maybe you’re content where it is today in terms of where your supply of owned lots can go. Obviously, as you option more land, that has some impact. But your supply of owned lots has been pretty steady in the four year range, maybe plus or minus over the last several years, even as the option share has moved higher. And I would think that would be one lever you could pull to further improve those turns.
So is there a target in mind? How low could that number go with your business model? Obviously, all your peers are closer to two years, but you have a bit of a different model there. So any color you can give there would be great.
Martin Connor: Sure, Alan. I think a long term goal for us is to get down to 2 to 2.5 years of owned land with almost a year’s worth of that owned land having a backlog home or a spec home on it in various stages of construction.
Operator: Thank you. And our next question today comes from Rafe Jadrosich with Bank of America. Please go ahead.
Rafe Jadrosich: Hi, good morning. It’s Rafe. Thanks for taking my question. Just following up on the last question on the difference between spec and BTO. Can you talk a little bit about the return on inventory on spec or return on equity on spec versus the build-to-order?
Douglas Yearley: Sure. The spec homes on average take about two months less to build and deliver.
Rafe Jadrosich: Got it.
Martin Connor: So, Rafe, the return on equity from the spec homes is a little higher than the return on equity for the build-to-order homes. And the inverse relationship of the gross margin is the balance we’re trying to play there.
Rafe Jadrosich: Got it. That makes sense. It’s very helpful. And then just on the order commentary for the first quarter, so what you’re seeing quarter-to-date comment that it’s sort of generally in line with normal seasonality or little — maybe a little bit better. You do have more communities right now. And then mortgage rates, as you said, have come down. Why wouldn’t it be better than normal seasonality? Is that just because October didn’t actually really slow that much, or is it just a slow period in December? Is there community timing? How come it’s not better than normal seasonality, just given you have some incremental tailwinds quarter to date?
