DR Horton Inc. (DHI) Q3 2022 Earnings Call Transcript

DR Horton Inc. (NYSE: DHI) Q3 2022 earnings call dated Jul. 21, 2022

Corporate Participants:

Jessica Hansen — Vice President of Investor Relations And Communications

David V. Auld — President And Chief Executive Officer

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Analysts:

John Lovallo — UBS — Analyst

Carl Reichardt — BTIG — Analyst

Stephen Kim — Evercore ISI — Analyst

Eric Bosshard — Cleveland Research Company — Analyst

Mike Rehaut — JPMorgan — Analyst

Matthew Bouley — Barclays — Analyst

Alan Ratner — Zelman & Associates — Analyst

Truman Patterson — Wolfe Research — Analyst

Susan Maklari — Goldman Sachs — Analyst

Deepa Raghavan — Wells Fargo Securities — Analyst

Asher Sohnen — Citigroup — Analyst

Rafe Jadrosich — Bank of America — Analyst

Presentation:

Operator

Good morning, and welcome to the Third Quarter 2022 Earnings Conference Call for D.R. Horton, America’s Builder, the largest builder in the United States. [Operator Instructions]

I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton.

Jessica Hansen — Vice President of Investor Relations And Communications

Thank you, Paul, and good morning. Welcome to our call to discuss our results for the third quarter of fiscal 2022. Before we get started, today’s call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although D.R. Horton believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to D.R. Horton on the date of this conference call, and D.R. Horton does not undertake any obligation to publicly update or revise any forward-looking statements.

Additional information about factors that could lead to material changes in performance is contained in D.R. Horton’s annual report on Form 10-K and its most recent quarterly report on Form 10-Q, both of which are filed with the Securities and Exchange Commission. This morning’s earnings release can be found on our website at investor.drhorton.com, and we plan to file our 10-Q tomorrow. After this call, we will post updated investor and supplementary data presentations to our Investor Relations site on the Presentations section under News and Events for your reference.

Now I will turn the call over to David Auld, our President and CEO.

David V. Auld — President And Chief Executive Officer

Thank you, Jessica, and good morning. I am pleased to also be joined on this call by Mike Murray and Paul Romanowski. our Executive Vice President and Co-Chief Operating Officers; and Bill Wheat, our Executive Vice President and Chief Financial Officer. The D.R. Horton team delivered a strong third quarter, highlighted by a 53% increase in earnings to $4.67 per diluted share. Our consolidated pretax income increased 54% to $2.2 billion on a 21% increase in revenues. And our consolidated pretax profit margin improved 540 basis points to 24.8%. Our homebuilding return on inventory for the trailing 12 months ended June 30 was 41.7%, and our consolidated return on equity for the same period was 35.1%. These results reflect our experienced teams, their production capabilities and our ability to leverage D.R. Horton’s scale across our broad geographic footprint. Housing market demand remained strong during most of the quarter. In June, we began to see a moderation in demand and an increase in cancellations due to the rapid rise in mortgage rate and continued inflationary pressures across most of the economy.

The supply of both new and resale homes at affordable prices remains limited. Although demand has slowed from the frenzy pace we experienced over the past year, there are still qualified buyers in the market today as household formations continue and inflationary pressures drive rents higher. 54% of the homes we closed in the past 12 months were priced under $350,000, and our average sales price is approximately $100,000 lower than the average other homebuilders, positioning us to continue aggregating share. There are still disruptions in the supply chain and tightness in the labor market that continue to delay the completion of our homes under construction. These construction delays and changes in demand environment led us to reduce our full-year closing guidance for fiscal 2022.

We remain purposefully — we purposely slowed our number of home starts in the third quarter to position our inventory to align with market conditions. Although the uncertainty of this market transition may persist for some time, we believe we are well positioned to meet changing market conditions with our experienced teams, affordable product offerings, flexible lot supply and their strong trade and supplier relationships. The strength of our balance sheet, liquidity and loan leverage provide a significant financial flexibility, and we will continue managing our product offerings, incentives, home pricing, sales pace and inventory levels to optimize returns.

Mike?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Earnings for the third quarter of fiscal 2022 increased 53% to $4.67 per diluted share compared to $3.06 per share in the prior-year quarter. Net income for the quarter increased 48% to $1.6 billion on consolidated revenue of $8.8 billion, which was in line with our expectations. Our third quarter home sales revenues increased 18% to $8.3 billion on 21,308 homes closed, up from $7 billion on 21,588 homes closed in the prior year. Continued construction delays caused by disruptions in the supply chain and tightness in the labor market caused us to close fewer homes than expected during the quarter. Our average closing price for the quarter was $391,200, up 20% from the prior-year quarter.

Paul?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

During the quarter, we continued to sell homes later in the construction cycle to better ensure the certainty of the home close date for our homebuyers, with almost no sales occurring prior to start of home construction. In June, our sales pace slowed and our cancellation rate increased when mortgage interest rates rose significantly. The cancellation rate for the third quarter was 24% compared to 17% in the prior-year quarter. As a result, our net sales orders in the third quarter decreased 7% to 16,693 homes, and our total net sales order value increased 8% from the prior year to $6.9 billion. Our average number of active selling communities increased 5% from the prior-year quarter and was up 1% sequentially. The average sales price of net sales orders in the third quarter was $415,800, up 16% from the prior-year quarter.

Bill?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Our gross profit margin on home sales revenues in the third quarter was 30.1%, up 120 basis points sequentially from the March quarter. On a per square foot basis, home sales revenues were up 3.9% sequentially while stick and brick cost per square foot increased 2.4%. The increase in our gross margin from March to June reflects the broad strength of the housing market we experienced most of this year. The strong demand for homes, combined with a limited supply allowed us to raise prices and maintain a very low level of sales incentives in most of our communities. As we have already mentioned, demand has moderated in June and to date in July. As we adjust to current market conditions, we expect the pace of our sales price increases to slow during the fourth quarter and for our incentive levels to increase from historical lows. To address affordability concerns, we are offering mortgage interest rate locks and buydowns to our buyers, and we are beginning to offer other sales incentives as necessary on selected homes and inventory and to drive sales traffic to our communities. We currently expect our home sales gross margin in the fourth quarter to be lower than the third quarter.

Jessica?

Jessica Hansen — Vice President of Investor Relations And Communications

In the third quarter, homebuilding SG&A expense as a percentage of revenues was 6.6%, down 50 basis points from 7.1% in the prior-year quarter. This quarter, our homebuilding SG&A expense as a percentage of revenues was lower than any quarter in our history, and we remain focused on controlling our SG&A while ensuring their infrastructure adequately supports our business.

Paul?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

We purposefully slowed our home starts to 17,900 homes this quarter, as we work to position our inventory with an appropriate number of homes relative to market conditions. We ended the quarter with 56,400 homes in inventory, up 19% from a year ago and down 6% sequentially. 27,200 of our total homes at June 30 were unsold, of which 1,400 were completed. For homes we closed this quarter, our construction cycle time increased by roughly one week compared to the second quarter as supply chain issues remain challenging as they have for the past year. However, we are beginning to see some stabilization in cycle times on homes we have recently started. During the quarter, we will evaluate demand and adjust our homes in inventory and starts pace to meet current market conditions.

Mike?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

At June 30, our homebuilding lot position consisted of approximately 600,000 lots, of which 22% were owned and 78% were controlled through purchase contracts. 24% of our total owned lots are finished and 47% of our controlled lots are or will be finished when we purchase them. Our large capital-efficient and flexible lot portfolio is a key to our strong competitive position. Our third quarter homebuilding investments in lots, land and development totaled $1.75 billion, of which $890 million was for finished lots, $680 million was for land development and $180 million was to acquire land.

Paul?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

For the third quarter, Forestar, our majority-owned residential lot development company, reported total revenues of $308.5 million and pretax income of $52.7 million. For the full year, Forestar now expects to deliver 17,000 lots and generate $1.4 billion of revenue with a pretax profit margin of greater than 14%. Forestar’s owned and controlled lot position at June 30 totaled 97,000 lots, essentially flat with a year ago. 59% of Forestar’s owned lots are under contract with or subject to a right of first offer to D.R. Horton. $258 million of our finished lots purchased in the third quarter were from Forestar. Forestar is separately capitalized from D.R. Horton and had approximately $500 million of liquidity at quarter end with a net debt-to-capital ratio of 32.8%. Forestar is well positioned to meet changing market conditions with its strong capitalization, lot supply and relationship with D.R. Horton.

Bill?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Financial services pretax income in the third quarter was $128.3 million, with a pretax profit margin of 50.5% compared to $70.3 million and 37.3% in the prior-year quarter. The increase in our financial services pretax profit margin this quarter was primarily due to a significant acceleration of interest rate lot commitments. During the third quarter, a majority of our buyers in backlog for expected fourth quarter closings entered into interest rate lot commitments. These lots were executed earlier than normal due to the increase in mortgage rates, which resulted in higher-than-normal financial services revenue in the third quarter. This revenue acceleration will likely cause our financial services revenues and profits to be lower than normal in the fourth quarter.

For the quarter, 99% of our mortgage company’s loan originations related to homes closed by our homebuilding operations, and our mortgage company handled the financing for 69% of our homebuyers. FHA and VA loans accounted for 41% of the mortgage company’s volume. Borrowers originating loans with DHI Mortgage this quarter had an average FICO score of 724 and an average loan-to-value ratio of 88%. First-time homebuyers represented 56% of the closings handled by the mortgage company this quarter.

Mike?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Our rental operations generated pretax income of $43 million on revenues of $110 million in the third quarter related to the sale of one multifamily rental property consisting of 298 units and one single-family rental property totaling 84 homes. During the nine months ended June 30, our rental operations generated pretax income of $215 million on revenues of $489 million. Our rental property inventory at June 30 was $2 billion, compared to $760 million a year ago. Rental property inventory at June 30 included approximately $700 million of multifamily rental properties and $1.3 billion of single-family rental properties. As a reminder, our multifamily and single-family rental sales and inventories are reported in our rental segment and are not included in our homebuilding segments homes closed, revenues or inventories. We continue to expect that our rental operations will generate approximately $800 million in revenues during fiscal 2022. We plan to continue growing our rental inventories as we position our rental operations to be a significant contributor to our revenues, profits and returns in future years.

Bill?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Our balanced capital approach focuses on being disciplined, flexible and opportunistic. At June 30, we had $2.8 billion of homebuilding liquidity, consisting of $1.2 billion of unrestricted homebuilding cash and $1.6 billion of available capacity on our homebuilding revolving credit facility. Our homebuilding leverage was 17% at the end of June, and homebuilding leverage net of cash was 12.1%. Our consolidated leverage at June 30 was 24.9%, and consolidated leverage net of cash was 19.3%. At June 30, our stockholders’ equity was $18.1 billion and book value per share was $52, up 35% from a year ago. For the trailing 12 months ended June, our return on equity was 35.1% compared to 29.5% a year ago. During the first nine months of the year, our cash provided by homebuilding operations was $125 million.

During the quarter, we paid cash dividends of $79.2 million, and our Board has declared a quarterly dividend at the same level as last quarter to be paid in August. We repurchased 4.7 million shares of common stock for $310 million during the quarter for a total of 10.5 million shares repurchased fiscal year-to-date for $854.2 million, an increase of 29% compared to the same period a year ago. As a result, our outstanding share count at June 30 was down 3% from a year ago. We still expect our outstanding share count will be approximately 3% lower at the end of fiscal 2022 than the end of fiscal 2021.

Jessica?

Jessica Hansen — Vice President of Investor Relations And Communications

We are providing guidance for our fourth fiscal quarter. However, due to the current uncertainty in the market, the ranges for our volume and margin guidance are wider than normal. Based on the projected completion dates of our homes under construction and current market conditions, we expect to generate consolidated revenues in the fourth quarter of $10 billion to $10.8 billion, and homes closed by our homebuilding operations to be in the range of 23,500 to 25,500 homes. We expect our home sales gross margin in the fourth quarter to be in the range of 29% to 29.8%, and homebuilding SG&A as a percentage of revenues to be around 6.3%. We anticipate our financial services pretax profit margin in the fourth quarter to be less than 20% due to the timing of revenues from interest rate lot commitments as we discussed earlier. We expect our income tax rate to be approximately 24% in the fourth quarter. We plan to continue to balance our cash flow utilization priorities among our core homebuilding operations, our rental operations, maintaining conservative homebuilding leverage and strong liquidity and consistently paying dividends and repurchasing shares.

David?

David V. Auld — President And Chief Executive Officer

In closing, our results and position reflect our experienced teams and production capabilities, industry-leading market share, broad geographic footprint and diverse product offerings across our multiple brands. Our strong balance sheet, liquidity and loan leverage provide us with significant financial flexibility to effectively operate in changing economic conditions and continue aggregating market share. We plan to maintain our disciplined approach to investing capital to enhance the long-term value of the company, which includes returning capital to our shareholders through both dividends and share repurchases on a consistent basis.

Thank you to the entire D.R. Horton team for your focus and hard work. We are incredibly well positioned to continue improving our operations and providing home ownership opportunities to more American families. This concludes our prepared remarks. We will now host questions.

Questions and Answers:

Operator

Thank you [Operator Instructions] And the first question is coming from John Lovallo from UBS.

John Lovallo — UBS — Analyst

[Technical Issues] First question is, in early June, you had mentioned needing about 18,000 orders to hit the full-year delivery target. I mean the market has obviously changed since then, but you’ve delivered 59,000 year-to-date. There’s another 29,000 in backlog, which would give you 88,000 deliveries without even converting any of the fourth quarter orders. So what I’m trying to understand is, does the lower delivery outlook reflect concerns about cancellations, construction delays or both?

Jessica Hansen — Vice President of Investor Relations And Communications

We have had continued construction delays, but we also recognize the market has softened. And so we feel like we’re very well positioned to deliver on what our new guide is for closings. But as I alluded to, I mean, our ranges are bigger than they normally would be because of some of the uncertainty in the market. And so there’s upside to our closings guide. There’s also downside. I mean we really are going to see how it plays out as we work throughout the quarter, but we’re confident in our people, are going to continue to improve, and we’ll ultimately see some improvement in our construction cycle times and start converting houses to closings.

John Lovallo — UBS — Analyst

Great. And then, what has been your ability to resell the cancellations? And has there been a meaningful ASP or margin hit to those sales?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

It’s been — still been very strong, John. We’ve still been able to resell those cancellations. It just doesn’t happen immediately. By the time you resell it and requalify a buyer through the mortgage process, it could be a four- to eight-week to 12-week process sometimes. But we’re still seeing good demand for the homes that we have.

John Lovallo — UBS — Analyst

Great. Thanks guys.

Operator

And the next question is coming from Carl Reichardt from BTIG. Carl, your line is live.

Carl Reichardt — BTIG — Analyst

Thanks. Good morning everybody. I wanted to ask about the change in cancellations as you guys look at this — is your sense that this is really just a mathematics issue, high rates, higher prices, folks can’t afford? Or is this more psychological? In other words, folks are a little scared of what the value of their house might do, they’re concerned about the economy or their jobs. I’d just like sort of your sense, especially compared to past cycles of how you see the acceleration in cans, which you’d attribute that to.

David V. Auld — President And Chief Executive Officer

John, I think it’s probably a little of both. I think payment shock was part of it. Toward the end of June, middle of June, we had a 100 basis point increase in long-term rates over about a three- or four-day period. I think, that impacted it. Most people still remember 2008, ’09, ’10 when — worst housing market I’ve ever seen and values deteriorated, which, again, not typical in our history of our country. So I’ll pause. I mean I feel very good about where we’re headed market-wise and the response we’re getting as we continue to sell houses out there. So — but you increase rates a 100 basis points in four days, it does impact buyer psyche.

Carl Reichardt — BTIG — Analyst

Yes. Okay. And then second question, just on the delays you’re seeing in terms of vertical construction. How are delays related to horizontal? So is — are you seeing issues that would prevent you from getting the communities open that you have internally in your plan? Or if that were to change, would that be more a function just of a slowing market?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

I think it’s a little bit of both. But yes, I mean we have seen delays in the permitting process and bringing communities online, in addition to the delays that we’ve seen on the vertical side. And so if you look at that in aggregate, and hence, our guide to — lower than what we had previously been guiding to. I don’t think that it’s getting necessarily better today, any different than — we’re starting to see it stabilize some on the vertical side. The horizontal side, I think, will continue to be a challenge in terms of bringing new communities online on time.

Carl Reichardt — BTIG — Analyst

Thanks, Paul. Thanks everybody.

Jessica Hansen — Vice President of Investor Relations And Communications

Thanks, Carl.

Operator

And the next question is coming from Stephen Kim from Evercore ISI. Stephen, your line is live.

Stephen Kim — Evercore ISI — Analyst

Great. Thanks very much guys. Yes, I wanted to talk a little bit about your inventory management. You gave a lot of statistics that are very helpful in terms of spec levels. Your finished specs are, I think, 1,400, still pretty well below normal. Your under construction specs are quite high, and I assume that’s due to the cycle time. So — and then you gave some numbers around the land inventories — land spend. So I wanted to just ask where should we be thinking your finished specs? What is the desired level that you want to get to? And as that number increases, what should we expect to see for your under construction spec levels? And with the overarching view to try to get a sense for where your construction, your CIP, construction and process inventory in dollars may go over the next couple of quarters as you see it?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Sure, Steve. In terms of our completed spec homes, we’re always looking to sell those as quickly as we can. We’ve been at abnormally low levels. Still the 1,400 we’re at today is still relatively low. But if you look historically, we’ve typically been at levels quite a bit higher. So I think we’re seeing a return to a more normal level on completed specs, but the goal will always be to not have more than one or two completed specs at a community and continue to make sure that we move through those, and that they don’t age. In terms of our overall production, historically, when we had historically normal cycle times, you could anticipate us turning our housing inventory, our number of homes and inventory twice each year. We’ve been a little slower than that this year with the elongated cycle times.

But we’re looking to into next year, hopeful that we’ll see the improvements in cycle times and could get back to a more normal level there as well. And so we’re adjusting our starts to reflect the current moderation in demand, and we’ll be monitoring demand very closely to determine the appropriate level of starts, going forward. But then, as part of that total production that we look to turn twice historically, our spec levels as a percentage of that total have ranged from the low 40s to the low 50s. And so right now, we’re kind of in that normal total spec range, overall. And — so we’ll just be adjusting our starts space, looking at our overall homes and inventory and our spec levels and alongside demand over the coming months to position ourselves as best we can through the current market.

Stephen Kim — Evercore ISI — Analyst

So just to clarify on that, Bill, do you think that your construction in progress, in dollars, is likely to rise as we go forward here over the next couple of quarters?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

I think on a cost per home basis, we have been seeing that rise with cost inflation. And so I think there’s an element of that, that yes, that will remain. But our homes and inventory, our total number of homes and inventory are expected to decline in the fourth quarter from the current level. And that’s fairly normal for us in the fourth quarter as well as we deliver more homes typically than we start in a fourth quarter.

Stephen Kim — Evercore ISI — Analyst

Yes. Okay. So you got some seasonal factors there. Shifting gears to the incentive levels, amidst this buyer strike that we got right now. I guess I’m curious, where the level of incentives are versus what is normal in your business, recognizing that recently, it’s been incredibly low? But where are we now relative to what you would consider normal? And how much higher than normal do you expect to go near term, meaning in the next quarter or so?

David V. Auld — President And Chief Executive Officer

I would say, right now, we’re probably still lower than what we would consider a normal incentive. There are still a lot of buyers out there chasing homes. Finding qualified buyers is a little more difficult. Actually, reopening in the — some of our sales efforts has been interesting. So — but overall, I’d say the incentive program today is probably less than normal. I anticipate at some point, it will return to normal. There’s still not a lot of inventory out there for people to buy.

Jessica Hansen — Vice President of Investor Relations And Communications

And where they go will ultimately be tied to market demand. And we’ll do what we typically do, which is manage it market by market, community by community to maximize returns.

Stephen Kim — Evercore ISI — Analyst

Absolutely. Well, thanks very much guys. Appreciate it.

Operator

And the next question is coming from Eric Bosshard from Cleveland Research Company. Eric, your line is live.

Eric Bosshard — Cleveland Research Company — Analyst

Good morning. Thank you. Just curious if you could drill down a bit more to the last 30 or 45 days where you’ve seen the inflection. And I guess, specifically — I understand the comment, there’s still a lot of buyers out there, but curious, what has happened with cancellation rates? Obviously, the 24 in the quarter feels like that’s more elevated in this more recent period of time. Where has that been? And what is the expectation for that as we look into 4Q?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Cancellation rates during the quarter. In the first part of the quarter, they were in the normal range. For us, we had been, for a while, below normal. So it was in the normal range. And then it did definitely increased sharply in June, which then brought the overall average for the quarter up. As far as today in July, I would still say it’s elevated, has not continued on a trend much higher, but it still is at an elevated level. And so we’re monitoring that along with our gross sales activity and responses to incentives and other affordability measures we’re trying to provide for our homebuyers. And we’ll be monitoring that very closely, going forward. But like we’ve said thus far, we’re still seeing a very good level of core demand out there. We’re reselling our cancellations rather smoothly thus far. And so we’re hopeful that we’ll find some stability here in the demand environment in our sales and cans environment over the next few months.

Eric Bosshard — Cleveland Research Company — Analyst

And then secondly, if you could, in terms of either mix or geography, I’m curious if there’s any variation or any difference in behavior on sort of entry level versus within the move up or higher end of your price points. So from a geographic standpoint, is there any differentiation? Or is the higher rates had a similar impact across price points, product and geographies?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

I think there’s certainly more impact, potentially, on the buyers that are mortgage rate sensitive, but we still saw 56% of our closings were first-time homebuyers in the quarter. And we closed a substantial number of homes in June to those first-time homebuyers that need a place to live. We’ve been able to provide some interest rate lot products from our mortgage company that’s given those buyers comfort and certainty around payment. But they’re still buying a home out of need and necessity, buyers that are more discretionary in nature. And as question earlier alluded to qualification versus value expectations, they’re probably more in the value expectations side of taking a pause this summer and seeing where the housing market goes. But the biggest part of our business is focused primarily on the first-time buyer, first-time move up and providing an affordable home. So we’re still seeing people buying our homes out of need.

Eric Bosshard — Cleveland Research Company — Analyst

That’s helpful. Thank you.

Operator

And the next question is coming from Mike Rehaut from JPMorgan. Mike, your line is live.

Mike Rehaut — JPMorgan — Analyst

Thanks. Good morning, everyone. Appreciate all the comments and guidance. I wanted to drill down a little bit, if possible, on the gross margin guidance and the current rate of incentives that we’ve heard have increased over the last one or two months when we’ve heard in our conversations with different private builders, incentives are up anywhere from 100 to 300 basis points. Your guidance midpoint is down only about roughly 100 bps sequentially. So it’d seem that you’re at the lower end of that, let’s say, if that range is accurate, the 100 to 300.

So I just want to make — does that make sense to you in terms of those comments that make sense in terms of what we’ve heard. And do you think this increase that you’ve had in the last one or two months, has that, in effect, kind of brought sales pace back into a desired level? Or are you seeing incentives continue to rise as we’re working through in July?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Mike, I’ll start with the gross margin, and these guys may chime in a little bit more on the trends on incentives going forward. Gross margin guide itself — it starts with our backlog as we enter the quarter. And as we mentioned, we had a lot of buyers that locked in their mortgage rates that they’re expecting to close in Q4. And so we have more visibility to those homes that we expect to close in Q4 to the margins we expect to see there. So that’s the biggest piece of our visibility into our guide. We do still have some homes that we are selling in the current quarter that we will close, and those homes are more likely to be a little more exposed to the current incentive environment.

And so we’d expect there to be a few more incentives in some of those homes, which has been factored into the guide as well. And so I think your comments in the market around level of incentives, I don’t — I wouldn’t say those are inaccurate at all. But our closings in the coming quarter will partially reflect some of the current environment, but will also reflect some buyers that are in backlog and have their rates locked and are marching towards closing in Q4.

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

The margin guidance, we talked about earlier, is also reflective of the cost environment that we faced over the past six to nine months as we started homes at different times and at different lumber pricing, frankly, was a big driver of it. General inflationary pressures across most of our cost categories. But certainly, the lumber has had a great deal of variability over the past 12 months. It rose significantly, fell off a bit, it went back up again and now it’s back down. So as those homes push through the production process and deliver, they’re going to have an impact on the gross margin as well.

Mike Rehaut — JPMorgan — Analyst

Great. No, that’s very helpful. Appreciate that color. Secondly, you highlighted earlier in your prepared remarks about the continued levels of share repurchase. How should we — I know it’s a little forward-looking. And you’ve been on a pace over the last couple of years, where you’ve been reducing your share count low single digits. To the extent that we’re in, obviously, a little bit of a softer market and that moderately softer levels continue. How should we think about share repurchase for fiscal ’23? And assuming things don’t fall off a cliff, but they’re obviously still at a more moderate rate, would you dial it back? Or given the strength of your balance sheet and still strong cash flows and very healthy margins, should we expect some level of continued share repurchase in ’23?

David V. Auld — President And Chief Executive Officer

Our plan from day one has been consistent over time, balanced with — supporting the homebuilding inventories and funding the growth. I don’t see that changing in ’23, ’24 or ’25. We just — our goal is to be out there, operating consistently, growing our market share, expanding homeownership opportunity for as many families as we possibly can. And I don’t see that changing.

Mike Rehaut — JPMorgan — Analyst

Great. Thanks so much.

Operator

And the next question is coming from Matthew Bouley from Barclays. Matthew, your line is live.

Matthew Bouley — Barclays — Analyst

Good morning everyone. Thank you for taking the questions. Just another one on gross margins, asked a different way here. I know the visibility to ’23 is limited here. But I guess, in an environment where incentives do return to normal, as David alluded to earlier, just curious if you could outline kind of how the gross margin of the business might look in such a scenario.

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Well, anytime we see a change in market conditions. And right now, we do expect the level of price increases to moderate and start to flatten out. We’ve already talked a bit about incentives rising. The top line is impacted quicker than our costs are. So we usually see two or three quarters where our higher costs are still coming through, and that puts some pressure on near-term margins. But then as that inflection begins, it opens the door up to be able to start addressing on the cost side. We’ve already seen some relief from lumber, which that will start to be more of a tailwind for us in coming quarters.

And then other categories really beginning with labor becomes an opportunity as well. And so our goal will be to do as much as we can on the cost side to offset the impact that we see from prices flattening and incentive levels to maintain as good a margin as we can, balance with pace to generate the best returns that we can generate. Where that will be, will depend on — will be dependent on the strength of the housing market and demand.

David V. Auld — President And Chief Executive Officer

Ultimately, it’s going to come down to what drives the best return for that individual flag. Same formula we’ve been working on — working with — for the — coming out of the downturn. Our long-term focus is returning the best we can with the inventory that we put out there, and that’s not going to change. We deemphasized gross margins when we could deliver every house we wanted to build as the construction process became more and more challenging, we expanded margins because we were delivering every house we possibly could. At the end of the day, it’s returned, it’s ROI, it’s ROE. That’s our focus.

Matthew Bouley — Barclays — Analyst

Got you. That’s really helpful, gentlemen. And then second one, I have to ask the impairment question, which obviously at a 30% gross margin. We’re not near anything like that at this point, but given it is an investor concern here. So I guess the way to ask the question is, within your portfolio, certainly, there’s going to be communities below the average by definition. But is there any — would you be able to highlight or point to any portion of the portfolio that might be more vulnerable to something like impairments, where the home price declines may not be as severe as you might look on a national average? Just basically, what portion of the portfolio would you consider to be potentially more vulnerable to impairments, the longer that this type of softness in housing persists?

Jessica Hansen — Vice President of Investor Relations And Communications

Sure, Matt. I think you led with the most important point, which is we’re starting at a 30% gross margin. So that really signifies that we’re a long way off from any sort of broad-based impairments. It would take significant margin erosion from declines in home prices. We don’t have any projects right now that are what we deem internally on our watch list because they’re approaching a gross margin that we would have to do a more thorough impairment analysis. And to really see even any sort of pickup in a watch list before we even get to the point of impairments, we’d have to see a pretty big home price decline. So I wouldn’t say there’s any one piece of our portfolio right now that we would point to as being at higher risk than others. But certainly, as we continue to move through a market transition, if there are certain markets where home prices come down further than others, those would be the ones we’d point to first.

Matthew Bouley — Barclays — Analyst

All right. Thank you, Jessica. Thanks everybody.

Operator

And the next question is coming from Alan Ratner from Zelman & Associates. Alan, your line is live.

Alan Ratner — Zelman & Associates — Analyst

Hey guys. Good morning. Thanks for taking my questions. First one on incentives. And I know it’s early innings as far as any meaningful increases there. But curious, what you’re seeing on the elasticity of those incentives where you are offering them? Are there certain markets where perhaps the incentives have been more effective at driving increased traffic and orders? And are there markets where, based on what you’re seeing so far, demand seems less elastic or maybe even inelastic to any increase in incentives?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

Alan, I don’t think we’ve seen a definite pattern as of yet. I think that the incentives that we have put out, as we’ve stated, are still, at this point, below historical norms, are being effective in terms of driving the traffic. Traffic in total has slowed, just based on the market conditions and the change that we’ve already talked about. But generally speaking, those incentives have accomplished what we’ve been trying to do in terms of driving additional traffic and converting the homes as our cancellation rate has rise. We’ve been able to convert those homes that are completed, and we still have a lot of buyers with a near-term need to get into a house. And so we’ll adjust as the market needs to, flag-by-flag, community-by-community drive the returns we’re looking for. And the pace is the driver of that.

Alan Ratner — Zelman & Associates — Analyst

Got it. Appreciate that. Second question, I would love to drill in a little bit on your build-for-rent business. Only one community sold this quarter, which was a bit lower than the last few quarters. But a lot of people have kind of talked about the — maybe the bull point where if kind of the core demand does soften for an extended period of time that there is all this capital on the sidelines targeting build-for-rent that perhaps might be able to fill at least part of that void. So curious what you’re seeing in your conversations with build-for-rent investors and the parties that you’re selling these communities to. Have you seen any shift in their appetite and as you market the next round of communities? I know you have some guidance for sales in the fourth quarter or maybe even thinking about early ’23. What’s your expectation for the demand in the BFR space?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

We still see very strong interest when we take communities to market and still very encouraged by that. Certainly, the valuation equation is heavily impacted by long-term financing costs for those investors. So — and in periods of volatility in those costs in their underwriting, it’s a little longer to get the process completed with these transactions, but there’s still tremendous demand for them. And they’re still on the front end of it, as we see these communities begin to complete units and we open up to leasing, we’re still seeing strong demand for people moving into the homes. And so that’s ultimately very encouraging as we’re creating cash flow assets that there is, as you mentioned, a lot of capital interested in investing in those assets today.

Alan Ratner — Zelman & Associates — Analyst

A follow-up on that, if I could. Have you shifted any communities that are earlier in the planning process from for sale to for rent when you look at your total lot pipeline pushing 600,000 lots. If you’re selling 80,000 homes a year, which is kind of your run rate for the year, roughly, it would seem like that’s a lot of land, probably more land than you need and perhaps there’s an opportunity to shift some of that to BFR more so than perhaps you thought a quarter or two ago.

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

We certainly evaluate that in terms of demand for the — for sale in our portfolio. If pace slows down in a given market, then our land position gets a little longer in that market. Looking for ways, we always thought build-to-rent is a great way to more rapidly monetize land positions without cannibalizing for-sale business because it’s a different user of that real estate and different owner of the real estate. So it brings other capital pools to bear. So we certainly have repurposed projects that we originally may have identified three to four years ago is for sale. Today, they’re being executed as for rent, and that process continues. I mean, we underwrite our land buys on the basis of a for-sale purchase. We do not look at the valuations from a build-to-rent aspect in underwriting land buys.

Alan Ratner — Zelman & Associates — Analyst

Appreciate that color. Thanks a lot guys.

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Thank you.

Operator

Thank you. And the next question is coming from Truman Patterson from Wolfe Research. Truman, your line is live.

Truman Patterson — Wolfe Research — Analyst

Hey. Good morning, everyone. Thanks for taking my questions. Hoping you all could just give an update on your June order exit rate as well as what you’re seeing in July. And then following up on Eric’s question, one of your peers kind of gave a lay of the land, based on metro or even regional performance. Just hoping you can give some color on the out or underperforming metros.

Jessica Hansen — Vice President of Investor Relations And Communications

I think we’re all looking at each other. Can you specify your first question on exit rate again, so we make sure we answer the right question?

Truman Patterson — Wolfe Research — Analyst

Yes, your June orders. Just trying to get an update there, what kind of the decline was and how July is trending?

Jessica Hansen — Vice President of Investor Relations And Communications

Okay. Well, we don’t ever speak to monthly orders specifically. That being said, we did guide at a conference in early June that we expected our sales to be essentially flat for the quarter on a year-over-year basis, and we came in down 7%. So that does tell you that in most of June — because rates spiked pretty quickly after we made those comments, most of June, we did see softening and June would have been our worst sales month of the quarter, as a result of both the moderation in demand and the pickup in cancellation rates that we’ve already talked to. And then I think Bill said earlier in one of his Q&A responses that our can rate hasn’t necessarily gotten worse since June, but it has stayed elevated into July, and sales have continued to be a challenge, but we do still see a decent level of demand out in the market and are selling and closing homes every day so far in July.

Truman Patterson — Wolfe Research — Analyst

Okay. Perfect. And then any color on any kind of problem metros or — metros you’re seeing outside strength?

David V. Auld — President And Chief Executive Officer

Texas, Florida, I think, are going to continue to drive national numbers. Carolina has continued to be stable and strong for us. We’re really — from a historical norm, from my history with the company and my history in the industry, it’s a good mark. I mean, talk about some areas being stressed or problematic, it just doesn’t exist today. Is there a pause? Is there a reset in kind of the prior expectation? Yes, absolutely. Payment shock when rates go up a 100 basis points in four days, yes, absolutely. But demographics, demand, the desire to get out of the, all those are enforced and continuing. And our expectations for next year are that we’re going to get back on pass, back on pace. So all good in D.R. Horton.

Truman Patterson — Wolfe Research — Analyst

Okay. Okay. Perfect. And then Matt asked about kind of owned-land impairments. But I want to ask a little differently. You all really transformed your balance sheet compared to the prior cycle, heavy option land position. Have you all started to rework any of those deals? And what sort of market conditions would you really need to see in order to perhaps walk from any of the more recent contracts?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

We’re constantly evaluating the land portfolio. That’s one of the benefits of having the option position we have is that we get the chance to continue to make decisions about projects as we move through them. Those land projects that we’ve — and neighborhood projects that we’ve identified in the portfolio, very important to the future deliveries of the company, and we’re going to continue to work through those neighborhoods. But everybody we work with understands that we’re all working together in the same market conditions and a change at the front end of selling homes to home buyers will ripple all the way through the value chain, and it starts ultimately with the land. So we will continue to rework our portfolio as needed. And we always are continually making adjustments to reflect current on-the-ground conditions, whether it’s an acceleration or deceleration of a given project.

Truman Patterson — Wolfe Research — Analyst

Okay. Thank you all.

Operator

[Operator Instructions] And the next question is coming from Susan Maklari from Goldman Sachs. Susan, your line is live.

Susan Maklari — Goldman Sachs — Analyst

Thank you. Good morning, everyone. My first question is going back to lumber. There’s some changes that are coming through in the future, better aligning them with how builders actually take the lumber in. Given the volatility that you’re seeing and the uncertainty in demand, are you considering — or would you think about perhaps starting to hedge some of those costs?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Is that a sales pitch for Goldman? Sorry.

Susan Maklari — Goldman Sachs — Analyst

No.

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

We have historically not tried to hedge any of those positions, and we work with our local suppliers and partners to bring the lumber to the job sites to the best value possible. We have not yet seen how those markets are going to function or evaluate it yet if that’s a possibility for us. But we will certainly look at things that make sense to offset risk in our business.

Susan Maklari — Goldman Sachs — Analyst

Yes. Okay. Okay. I appreciate that. My second question is on land spend. You obviously talked about what you allocated in the quarter. As you think about the upcoming year, any initial thoughts on where that may go and how to think about it relative to where you’ve been this year and perhaps last year even?

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Yes, Susan, we only own about 130,000 lots today. So we are constantly buying lots more and more. A larger percentage of our purchases are of finished lots and that we essentially put into production almost on a just-in-time basis. So we’ll be continuing to replenish our owned lot supply along the way. As Mike said, adjusting our option portfolio on a constant basis. So I would expect there’ll still be a steady reinvestment and replenishment of our land pipeline. Obviously, as we see how the current market conditions transition here, we’ll be evaluating the depth of demand, the strength of the demand and then positioning our land and our lots and our homes and inventory to match those conditions as we go into next year. And our spend will then align with the plans that we set.

Susan Maklari — Goldman Sachs — Analyst

Okay. All right. Great. Thank you. Good luck with everything.

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Thanks, Susan.

Operator

Thank you. And the next question is coming from Deepa Raghavan from Wells Fargo Securities. Deepa, your line is live.

Deepa Raghavan — Wells Fargo Securities — Analyst

Hi. Good morning, everyone. Thanks for taking my question. I had a follow-up on the prior question asked by Truman on market color. Wasn’t clear if that was a volume comment that you provided or pricing? I had a question on pricing, though. Can you talk through any surprise elements within your orders’ pricing trends, moderation or decline or were you surprised the resilience in some of your markets?

David V. Auld — President And Chief Executive Officer

Surprised. I don’t know that surprise is probably a great tone. We’re responding to — and it’s my belief, I think our belief that buyer demand is — I mean there’s still more housing formations, job creations than there are homes being built. And so I think we’ve talked about elongated cycles in the past. This pause disruption, could it get worse? Absolutely, it could. But I’ve been doing this for a long time. And in a conversation with one of our regional presidents a couple of days ago, we were talking about the market. And he and I both have been doing this a long time. Both have been in sales models when selling homes was very difficult. And this is probably the second best market ever. So I guess — I understand that there’s uncertainty out there.

But when you have people that want to buy homes, I mean, we’re going to adjust, we’re going to figure out how to put those people in homes. That’s what we do. And — so that’s market by market, flag-by-flag, division-by-division, however you want to cut it up, we’re going to build, sell, start. We’re going to start, build, sella and close homes and create homeownership opportunities. That’s what the mission of this company is. So that’s what we’re going to do.

Bill W. Wheat — Executive Vice President And Chief Financial Officer

And Deepa, just on the current trends, it’s still very early to determine exactly what magnitude of adjustments may occur. We’re still evaluating that on a week by week basis when — as David said earlier, when rates spike, there’s an adjustment period. And we’re in that adjustment period right now, where buyers are — there’s a little bit of a rate shock or a payment shock. And so they’re adjusting expectations, and we’re figuring out how to adjust with them to make sure we get them into the homes that they want to purchase.

Deepa Raghavan — Wells Fargo Securities — Analyst

Fair enough. My follow-up is on start space this quarter. The 17,000 starts pace, how much was trimmed by supply chain issues? And any thoughts on what could be a reasonable start space near term? I mean, look, frankly, I’m aware you’re unable to provide volume thoughts into 2023, but under what circumstances would you expect to grow over the 85,000 units guided here for 2022, just based on the start space that you’ve been printing recently?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

Deepa, looking at our starts, and we purposefully reduced that start pace over the last quarter, again, to meet the market, and that’s largely from production and production capacity, we had to had big start base the prior quarters leading into this and with continued challenges in the supply chain and the labor markets, giving our chance, giving our people and our vendors the ability to catch up and move those homes forward. And on a go-forward basis, we’ll adjust those start space to market conditions. So as we’ve mentioned, we’re still early in this pause period and adjustment. And as we find our base, we’ll maintain start space that we want to drive the units and deliveries we’re looking for.

Jessica Hansen — Vice President of Investor Relations And Communications

And too early to say anything on fiscal ’23, we’ll reassess in November. If we have a little bit more certainty in the market, then hopefully, we’ll be in a position to give some high-level guidance for the full year, but it’s going to depend on the market. And if it’s settled out, and we feel comfortable doing that or not, we’re always going to position ourselves to grow and consolidate market share. But it’s really going to be up to market conditions and what makes the most sense in terms of us maximizing our returns.

Bill W. Wheat — Executive Vice President And Chief Financial Officer

Part of that positioning, going into next year, is our number of homes and inventory. We have 56,000 homes in inventory, today, and we’re guiding to closing between 23.5 and 25.5 in the coming quarters. So we’re going to go into the year with inventory as well. And we’ll supplement it with our start space in Q4 and beyond to then drive to the volume levels that will drive next year.

Deepa Raghavan — Wells Fargo Securities — Analyst

Fair enough. Thanks very much and good luck.

David V. Auld — President And Chief Executive Officer

Thanks, Deepa.

Operator

Thank you. And the next question is coming from Anthony Pettinari from Citigroup. Anthony, your line is live.

Asher Sohnen — Citigroup — Analyst

Hi. This is Asher Sohnen on for Anthony. And I just wanted to ask, I think you’re currently selling homes on land that was largely or at least partially put under control prior to the pandemic. So just looking at the prices for lots that you’re putting under contract now and then trying to hold all else equal, would it be possible to sort of quantify how those gross margins on these new lots might compare to current gross margins? And just generally, very roughly, how long before you start to exhaust that favorable cost basis?

Jessica Hansen — Vice President of Investor Relations And Communications

Land prices vary across the country, and the rate of increases in land prices have varied. So we’ve talked to you each quarter what our lot costs have done on a square foot basis, and we’ve really not seen more than a low to mid-single-digit increase in terms of what’s flowing through our closing each quarter. And with the vast amount of land we’re buying on a quarter-to-quarter basis and it all being contracted for at different dates over — it maybe in the last year, it may be in the last three years that we contracted for it, we would expect to continue to see a relatively modest increase in lot costs flowing through in our future quarter closings.

Asher Sohnen — Citigroup — Analyst

Understood. And then, you slowed starts this quarter to better sort of match anticipated demand, if I heard correctly. So just on a strategic level, do you see D.R. Horton is maybe trying to gain share in the housing slowdown? Or how do you think about the level of discipline around supply/demand maybe among your peers and competitors compared to prior cycles?

David V. Auld — President And Chief Executive Officer

I think compared to prior cycles, the entire industry is much more disciplined, much more focused on cash flow, much more focused on return [Technical Issues] on accelerating land prices. So you look at our stores, you look at the industry stores, in June, I think, very, very fast reaction to the rate increases. We’ll see what happens in July and August. But our expectation is that you’re going to see starts stay disciplined. And when the rates stabilize and we can adjust pricing and offerings to the buyers and they’re comfortable buying them, then I think you’ll see starts pick back up. But it’s just a different world today than it was in ’04, ’05, ’06. You’ve got a real business that’s building houses today.

Bill W. Wheat — Executive Vice President And Chief Financial Officer

And then specific to market share gains, that’s always a core part of our strategy.

Asher Sohnen — Citigroup — Analyst

Okay. Thanks. I’ll turn it over.

Operator

Thank you. And the next question is coming from Rafe Jadrosich from Bank of America. Rafe, your line is live.

Rafe Jadrosich — Bank of America — Analyst

Hi, good morning. Thanks for taking my questions. I just wanted to follow-up on some of the comments on the July trend. In June, you talked about the moderation with the affordability shock and the spike in mortgage rate. Has demand sort of continue to decelerate? Or have we seen sort of a stabilization and reset?

Michael J. Murray — Executive Vice President And Co-Chief Operating Officer

Hard to say. It’s early into the quarter as to where we are. The past few summers, we’ve not seen much seasonal falloff. This year, I think we’re seeing a little more seasonality. But we still see traffic in the models. We still see people out buying homes. It’s not a zero environment. People are still moving into the homes that we complete and close. It’s probably coming back to a little more normal seasonality, where the middle of the summer gets a little bit slower from a traffic perspective.

Rafe Jadrosich — Bank of America — Analyst

Okay. That’s helpful. And then you commented on the material cost outlook and labor potentially coming down. Are you seeing land prices come down? Has there been any relief on that side with the slower demand in the market?

Paul J. Romanowski — Executive Vice President and Co-Chief Operating Officer

No, we really — I think as you look at this process — and again, we’re really at a pause in the market, and one of the last things we see to come down is going to be the land. It’s a little slower to react than — first, we probably see it in the labor on a localized basis and then materials and then land, will adjust over time, based on market conditions, just like it always has. It’s going to rise and flow a little behind housing demand.

David V. Auld — President And Chief Executive Officer

I will also say, Rafe. We have a very deep pipeline of house plan that we’ve controlled for multiple years. And it does put us in a position where if we see the imbalance in land pricing versus future market expectations, we don’t have to buy it. We’ve got the ability to pause in our land acquisition for an extended period if we think that’s the prudent decision.

Rafe Jadrosich — Bank of America — Analyst

That makes sense. Thank you.

Operator

Thank you. And ladies and gentlemen, that’s all the time we have for questions today. I would now like to hand the call back to David Auld for closing remarks.

David V. Auld — President And Chief Executive Officer

Thank you, Paul. We appreciate everybody’s time on the call today and look forward to speaking with you again to share our fourth quarter results in November. And to the D.R. Horton family, you are a driving force in the creation of affordable housing in this country. What you do is important. Don Horton and the entire executive team, thank you for your focus and hard work. Let’s finish this year and move on to ’23.

Operator

[Operator Closing Remarks]