KB Home skips mortgage rate buydowns that other builders are promoting

KB Home (KBH) isn't relying on mortgage rate buydowns like other homebuilders as rates top 7%. Instead, the builder is catering to buyers through customization and a rate lock.

"We're built to order...and with that customer, you're working to lock the rate and it costs a little more because you're further out, but they want comfort knowing they'll get the rate when the home is completed," CEO Jeffrey Mezger said on the company's quarter earnings call Wednesday after posting soft gross margins and an orders miss. "And other than that, we're not really doing financing concessions on our built-to-order sales."

"That buyer picks everything ... and it's all about the best price for the best value and they build it and they are happy at that price."

Mezger's comments came the same day the Federal Reserve held its benchmark interest rate steady but indicated that a quarter-point hike could come by the end of the year and that higher rates would stay for longer.

Read more: What the Fed rate-hike pause means for mortgage rates and loans

The rise in rates has only made buying a home tougher. The average rate on the 30-year fixed loan continues to linger above 7%, making housing affordability challenging.

Homebuilders across the country have rolled out juicier incentives to entice buyers back into the market. For some, that means offering aggressive rate buydowns when the builder pays upfront to reduce the interest rate on a mortgage for the buyer.

One example is Lennar (LEN), which is promoting a fixed mortgage rate of 4.25% in Colorado for buyers who "sign a purchase agreement on a select move-in ready home." That’s quite a difference from today’s current mortgage rate.

KB Home, however, used the perk sparingly, pulling it out only for a selective share of their customers.

"Any mortgage buydowns or points that we paid primarily went to moving inventory homes that were later along in the cycle and closer to closing," Robert McGibney, executive vice president and chief operating officer at KB Home, said on the earnings call.

The popularity of temporary mortgage rate buydowns rose as mortgage rates crossed over 6%, according to Corelogic, but now has started to slowly slide downward. This aligns with what KB Home executives have noticed between quarters.

"As far as the total percentage on mortgage concessions, it was roughly the same quarter-over-quarter, 1.6%, I believe, as a percentage of revenue this quarter versus 1.5% or 1.6% last quarter, so it stayed relatively flat quarter on quarter," McGibney added.

Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?

Residential single family homes construction by KB Home Residential single family homes construction by KB Home are shown under construction in the community of Valley Center, California, U.S. June 3, 2021.   REUTERS/Mike Blake
Residential single-family homes by KB Home Residential are shown under construction in the community of Valley Center, Calif., on June 3, 2021. (REUTERS/Mike Blake) (Mike Blake / reuters)

Overall, KBHS originated 84% of the mortgage loans the company’s homebuyers obtained to finance their home purchases, compared to 69% a year ago. Meanwhile, about 60% of the customers used a conventional mortgage and 90% used fixed-rate products. The average cash down payment held steady at 15% of the purchase price, equal to roughly $70,000 down.

"Even with one half of our buyers purchasing their first home in the quarter, we are attracting buyers above our targeted income levels with healthy credit who can qualify at elevated mortgage rates and make a significant downpayment," Mezger said.

Now and going forward

KB Home closed 3,375 homes in the third quarter, higher than Bloomberg analysts' expectations of 3,126 homes, but still 6.6% lower year over year. Meanwhile, the average selling price of a home this quarter was $466,300, down from the previous quarter of $479,500.

Its cancellation rate for the third quarter of 2023 stood at 21%, down from 22% from the previous quarter.

Customers' orders for new homes jumped 52% to 3,097 homes, pulling in "within our guided range to help the result during a seasonally slower time of year," Mezger noted. However, orders were still behind 3,385 analysts’ expectations.

FOLSOM, CALIFORNIA - MARCH 22: In an aerial view, a sign is posted in front of a KB Home housing development on March 22, 2023 in Folsom, California. Homebuilder KB Home will report first quarter earnings today after the closing bell. (Photo by Justin Sullivan/Getty Images)
In an aerial view, a sign is posted in front of a KB Home housing development on March 22 in Folsom, Calif. (Photo by Justin Sullivan/Getty Images) (Justin Sullivan via Getty Images)

On a per-community basis, monthly net orders climbed to 4.3 from 3.1, which were above the company’s historical third quarter average, prior to pandemic-driven volatility.

Going forward, KB Home warned of the seasonality changes ahead.

"With that in mind, and based on normal fourth quarter seasonality, we project a monthly absorption pace of between 3 and 4 net orders per community, producing a range of between 2,070 and 2,760 net orders in our fourth quarter," Mezger signaled.

Additionally, the homebuilder remains committed to focusing on the underserved segment —the first-time or move-up buyer. The builder’s core build to order strategy has been advantageous for this group by providing them with smaller dwellings. About 70% of their communities offer plans below 1,600 square feet.

"Smaller homes, which feature similar room counts and livability that are a more affordable option, offering a range of products and price points that buyers choose gives us early insight in how the market is moving, allowing us to adjust appropriately in the homes we model and price points we feature," Mezger said.

The builder expects fourth quarter home sales revenue of $1.55 billion to $1.65 billion, with home gross margins of 20.5% and to end the community count of 230. Some Wall Street analysts also are bullish despite the choppy rate environment.

"We believe the public homebuilders will continue to benefit from a tight resale market, increasingly strained private competitors and a resilient US homebuyer that has seemingly adjusted to a higher interest rate environment," John Lovallo, UBS analyst, wrote in note to clients following the results.

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.

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