Transcript
Dean Wehrli:
Welcome to New Home Insights, the John Burns Real Estate Consulting podcast by the US housing market. I’m your host Dean Wehrli. Today we have one of the giants of home building in the United States. We have Steve Hilton, the CEO of Meritage Homes. On this episode, we’ll range a little wider than just COVID-19. We’re going to talk about how Meritage is coping with COVID, yes, but also about how they have shifted their strategy even before COVID, how that’s playing out, and then maybe talk a little bit about design and trends through the lens of one of the biggest and best home builders in the country. Steve, why don’t you give us a quick intro and bio of you and Meritage Homes?
Steve Hilton:
Sure. I don’t know if we have enough time for the whole bio and intro, but Meritage has been building homes for 35 years. I co-founded the company with another gentlemen a couple years out of college here in the Phoenix, Arizona metropolitan market. We’ve built about 135,000 houses today across nine states in the Sun Belt. And today we’re the seventh largest builder in America, and we are focused on the entry-level and first move-up market.
Dean Wehrli:
Let’s start with that then. You have a program that you’ve transitioned to called LiVE.NOW. It’s kind of moving toward a more simple model for the buyer and for the builder yourself. First off, you spell LiVE.NOW with all caps, except for this lower case I in live. Steve, what happened there? Did you do focus groups on that or did you just get jealous that Taylor Morrison was spelling projects with numbers instead of letters?
Steve Hilton:
No. We had a very sophisticated algorithm that came up with that. I have no idea. You have to ask our marketing department about that.
Dean Wehrli:
I am fascinated by that.
Steve Hilton:
But it all started several years ago when we were doing a strategic business finding process and trying to figure out where we’re heading and how we’re going to separate ourselves from the pack. There’s a lot of mid-cap builders between let’s say five and 10 in the rankings that are doing a whole variety of product. We did entry-level, we did first move-up, we did second move-up, we did luxury, we did active adult and we really felt like we weren’t great at any of it. We did a pretty good job. We made money for our shareholders, but we wanted to be an exceptional company. We wanted to be a leader. In order to do that, we needed to really focus on our strategy.
We’ve been working our culture for many years. Matter of fact, there’s a book out called Culture Eats Strategy For Lunch. I don’t know if you’ve read it. Peter Drucker wrote it. It’s a famous book, but I kind of disagree. I think of course you have to have a culture to be a successful company, but you really got to have a strategy. So we decided to reformat our company to really get focused on the entry-level and be really, really good at it and to do first move-up and not do any of the rest that we were doing. And it’s really paid big dividends for us. Coincidentally, there’s 88 million millennials that are now in their peak home buying years and they’re driving a big portion of the housing market. So our strategy fit with the demographics, our business has become much more easier to operate. We’re more streamlined. It takes less people. It reduces our SG and A as a percentage of our revenues and it’s just a win-win all around.
Dean Wehrli:
So that’s the driver was both the demographics, where you saw the market going and also the strength of your company internally.
Steve Hilton:
Yeah. It’s a lot easier to build entry-level homes where you don’t have to process a lot of custom changes and upgrades and it’s easier to deliver a better customer satisfaction. On the flip side of that is you really got to be able to be disciplined about how you run your business. You got to have less product. You have to convince yourself the less is more. You have to be able to streamline and value engineer that product, because price is the number one amenity and you got to be able to execute. It didn’t happen overnight. It’s taken years for us to get to the point where we are. We still have room to improve, but we feel like we’re on the right path with the right strategy to really take advantage of the demographics that we’re looking at over the next decade.
Dean Wehrli:
Speaking of the culture though, was it difficult to get your team to pivot with you to shift from selling upgrades and purchasing those? Was there a process there?
Steve Hilton:
Yeah, absolutely. Any kind of change is always difficult. When you have a big organization, we have more than 1500 employees. It’s a complex industry, complex business. And to get people to think outside the old norms on how they think things should be done and get them to read a row the same direction is not easy, but we kept chipping away at it and working on it. And once some of our divisions got some entry-level communities online and other divisions saw the success of that, then everybody wanted to do it and everybody came following in. It’s not easy, but, but you got to, you got to have the will and the intestinal fortitude to stick with it and to make change happen.
Dean Wehrli:
How does it work in the sales office? What are just the logistics of it, I guess?
Steve Hilton:
Well, we have wonderful sales offices. We’ve got great salespeople. We’re more focused on selling a payment. In our LiVE.NOW product, we’re a 100% spec. We don’t sell homes, we don’t sell builder suits, we sell our existing inventory. Every home has a different price. We don’t have the traditional price sheet. We do have a screen, a big TV in the office. You can go right up to the screen, qualify the buyer, put in what they’re looking for, get to capture their name and email address so we can market to them, but we can look for what product we have available and when we can deliver and what the payment is. So if you want a four bedroom, two bath home and you want to buy 1800 square feet and you want to move in in the next 60, 90 days, we can go right up to that screen and we can see what our inventory is and boom, we can hit a button and you’ll have all that information on your phone or on your computer.
Dean Wehrli:
So it’s just been, it’s been massively simplified, hasn’t it? For the buyer?
Steve Hilton:
Massively simplified. We’ve really invested heavily in our virtual experience. And we’re selling a lot more homes, at least a large portion of the process virtually. And it’s really paid off for us in the COVID world that we’re in.
Dean Wehrli:
Is it universal now? Is every Meritage community LiVE.NOW?
Steve Hilton:
No, about two thirds of them are, and the other third are primarily first move-up. We define first move-up as the space between the FHA loan limit and the Fannie Mae loan limit. Generally, in most of our markets, it’s between three and 400,000, some markets it’s higher. And then we’ve just winded our way out of all of our other products that we do. Our luxury products, our second move-up products. We still have some active adult communities that we’re finishing up, but I’ve been disciplined about not buying any new land that doesn’t fit the entry-level or the first move-up segments.
Dean Wehrli:
Got you. Let’s talk about the market a bit now. What are the key drivers, market specific drivers that impact how you allocate resources across different markets that you’re in?
Steve Hilton:
Well, what’s driving the home building market right now is no secret. As you know, it’s really a perfect storm. We have the lowest interest rates in history. You can get a mortgage for 3% or less, which really makes homes incredibly affordable. We have the COVID dynamics where people want to live more suburban than urban, and where people want to be owners versus renters, and don’t want to live in the traditional multifamily projects where they’re close to their neighbors. They want the space so they can feel safer. And we have all this happening at the same time, and it’s driving demand really like I’ve never seen before in my entire career.
Dean Wehrli:
Do you think, speaking of mortgage rates, what if we had something … say they popped up like they did late 2018, early 2019 to three and a half, say 4%. Would that have an immediate impact do you think?
Steve Hilton:
Well, we certainly saw an impact in ’18, ’19 when they popped up because they popped up really fast. And people are addicted to these low rates and I’ve seen a lot of my career where the rates were above 6%. So I think when rates pop up, people pull back. Housing is an essential need. I like to say, you got to live under a roof somewhere. You can decide whether you want to be a renter or an owner, but you can’t live in a tent. If you need a house, you have children or you’re raising a family, you got school-aged children, you need a home. You’re going to have to buy at some point. You can delay that decision to a certain degree because you’re waiting maybe for rates to come back down or you think it’s a temporary blip like we saw in ’18, early ’19, but eventually you’re going to have to buy.
Dean Wehrli:
Are you guys tracking the tent market? Just, you never know. They’re getting pretty nice.
Steve Hilton:
Oh, tracking the tent market?
Dean Wehrli:
Potential competitor. I’m just saying, to be ultra-cautious.
Steve Hilton:
No, I was talking to my son the other day. I have a 16 year old son. I was feeling kind of guilty. I’ve never gone camping with him, but I guess it’s not too late.
Dean Wehrli:
No. You can go glamping just in case you want to ease into it. Any markets you’re particularly optimistic about over say the next five years or so?
Steve Hilton:
I like all the markets we’re in. We’re in like almost 20 MSAs. Our home market here in Phoenix is absolutely on fire. I love Colorado. Texas has been spectacular for us the last six months. And the South, we’re in five major markets in the South. Atlanta, Charlotte, Raleigh, Nashville, Greenville, and then in Florida, we’re in three markets in Florida. Those are great places also. These are pro-business places where they’re growing the population bases, growing jobs. And we’re in California as well. We’ve got a good business there, but it’s a really difficult place to be a builder. And obstacles continue to keep popping up that get in the way of making homes attainable and affordable, but we continue to duke it out there and deliver value conscious product.
Dean Wehrli:
Yeah. California doesn’t make it easy, but if you’re able to get product out here, it’s a nice market. You guys are doing great out here.
Steve Hilton:
Thank you.
Dean Wehrli:
The beginning of COVID was the shutdown and that was pretty brutal. Sales tanked pretty much for everyone everywhere. The market, as you mentioned, has come roaring back and it’s done so pretty quickly. Did it surprise you how quickly the market rebounded?
Steve Hilton:
Yeah, I think it surprised everybody, but we were able to figure out pretty early that we weren’t going to have a systemic and prolonged downturn at the magnet of the low interest rates. And the side effects of COVID were going to allow us to really make something out of this unfortunate circumstance our country has been in or world has been in. And so although we pulled back for a short period of time, we pivoted quickly and put two feet on the gas very quickly and it’s really paid big dividends for us. We bought many land deals that other builders dropped and the fact that we had spec home inventory, allowed us to capture sales due to the urgency the buyers had to react to COVID that other builders weren’t able to capitalize on.
Dean Wehrli:
In the post-COVID shutdown, I guess when things started to get better in the housing market after the worst of the shutdown of COVID, there is a lot of pent up demand, I think, of those folks who weren’t able to did not want to buy or canceled during the worst of the shutdown. Do you think we’re still in that making up for the pent up demand mode here in early August or have we gone beyond that?
Steve Hilton:
No. We’re way beyond that. We’re way beyond that. First of all, our sales in January and February were really strong. Sales till the second week of March were strong. We were down 8% for the month of March over last year. And we’re down 15% in April, but our orders were up 44% in may and 66% in June. And I can’t tell you the number for July, but I can tell you it’s big. So I think we’re way past making up for the lost sales from March and April. And we’re just in a new world right now and these rates are just phenomenal. And so it’s great right now.
Dean Wehrli:
Yeah. No, I agree. I did a little analysis in Northern California to sort of how long would it take to absorb that pent up demand? And my guess was it would be into maybe end of June it would be absorbed. So let’s see what happens in July and of course, July … and so far August has been phenomenal.
Steve Hilton:
Yeah. And we’re seeing people really start to move from these expensive metropolitan areas into the suburbs. Our business in Northern California, as you go out towards Sacramento and the Central Valley, we’re seeing a lot of people moving out of the city. Maybe they don’t live exactly in the city, but near the city out to these more suburban locations. And the same thing in Los Angeles and the same thing in almost every metro area that we build in is taking shape and it’s driving the housing market.
Dean Wehrli:
So let’s talk about those acquisitions. You’re definitely in acquisition mode, right?
Steve Hilton:
Acquisition of land?
Dean Wehrli:
Yes.
Steve Hilton:
Yeah. We’re buying land at a very aggressive fashion right now.
Dean Wehrli:
But the capital for land entitlement and development is still kind of scarce though, right? Are you guys finding it hard to get new land opportunities?
Steve Hilton:
Well, the capital, I think you’re referring to the capital for developers to create masterplan communities is scared?
Dean Wehrli:
Yes. Correct.
Steve Hilton:
But we are in some master point communities, but that’s not the principle element of our land strategy. Our land strategy is to go out and develop our own land, to buy a 100 acres of land and put three or 400 homes on it. One or two product types, maybe buy it on a staggered take down over two or three takes, but we don’t have to put all the land on our books day one and develop it as we go and deliver our own product with no competitors immediately adjacent to us. And we have plenty of capital for that. We have the lowest leverage in the history of our company and we’re sitting on the cash pile of almost a half a billion dollars. And we’re finding plenty of land that meets our underwriting criteria that we can grow into.
Dean Wehrli:
Okay. That’s interesting. Given the places where you want to be, you’re finding entitle-able land to be sufficient for what you need to do.
Steve Hilton:
Yeah. Not everywhere. Certain markets are more difficult than others particularly in California, but in other markets we’re finding the land that we need. I think the key is when your product is very efficient to build, and you can build homes with less costs than your competition, then you can be more aggressive in buying land because your land will underwrite better. And if you’re going to buy a bigger parcel of land, and you’re going to take a modest amount of entitlement risk, you can also leapfrog your way in front of the competition. And I think that’s the secret of what the largest builders in America do, what Horton does and what Lennar does and what we do and maybe a couple others. That’s why we’re getting market share because we’re buying bigger parcels. We’re doing the work ourselves, we’ve got lots of capital, we’ve got three and a half billion dollars of assets. We only have a billion dollars of debt, we’re lowly leveraged and we’re set up to win.
Dean Wehrli:
So you create your own place and then satisfy a market niche that is often just unsatisfied based on price.
Steve Hilton:
Yeah, I mean it’s a misnomer. I believed it for a long time. I’ve been in this business 35 … I believed you couldn’t make money in the entry-level, hard to make money when you’re selling a lower price product and you’re running a volume business. Absolutely not true. Absolutely not true. Who was it? Henry Ford said, build for the masses and eat with the classes. It’s so true. Right?
Dean Wehrli:
But he also forced you to buy a black car. You guys have a lot more colors.
Steve Hilton:
Yeah. He got some white ones not that long after, right?
Dean Wehrli:
Okay. So he went from black and white, a vast diversity of product. Let’s shift to trends and prognostications. My favorite part. Is the work from home trend, you mentioned it a minute ago, is that here to stay and is that going to continue to drive more demand into these outline areas in a way from urban areas?
Steve Hilton:
I think it is to some degree, but I think it’s more at the higher price points. I don’t think most of the blue-collar workers for the lower white-collar workers that are buying our homes are going to be necessarily candidates to work from home. We sell homes to policemen, school teachers, healthcare workers, you name it. But the people that are buying the entry-level homes, the LiVIE.NOW homes that we’ve been talking about, to do their job, they got to be at their place of business and they can’t do it on a computer.
Now as you move up the price ban, people that are in technology, that are in other professions, accounting, IT, a lot of those jobs can be done online and from home, and I think that will compel some of our move-up buyers to be looking for more bedrooms or places they can set up a desk in a home office. We actually got away from building what we call pocket offices because our customers really didn’t want them. They’d much prefer a bigger kitchen or laundry room or other spaces. So it’s about bedroom count and bedrooms can have many uses and certainly they can be a home office.
Dean Wehrli:
How about those folks who you are getting, those new work from home folks in your buyer pool. Is it true that they still need to be within shouting distance of their mothership? That is, if they do have a job that’s based in, let’s say Scottsdale and they’re home officing, but still they have to go in maybe once in a while so they’re not necessarily moving to Boise, they’re just moving a couple hours away within still that greater Phoenix area. Is that fair?
Steve Hilton:
Yeah. I don’t think it’s going to end up being a 100% work from home. It’s going to be more of a telecommuting kind of situation where you’re going to work from home two or three days a week, and you’re going to be in the office two or three days a week. And maybe you’re going to be sharing an office or hotel in an office with somebody else. But I think most of their jobs are going to require some human interaction and they’re going to require some engagement with other employees’ collaboration. So I know at our company, we’re experimenting with telecommuting right now, but we’re not letting anybody leave the city and move somewhere else and go 100% online. That’s just not really in our strategy and playbook yet and I don’t expect it to be the wave of the future.
Dean Wehrli:
That’s still though, at least temporarily, that means more home offices. Are you going back to the pocket offices and starting to put those in your plans?
Steve Hilton:
Not quite yet. We’re exploring it, we’re examining it. We’re talking to our customers. We do a lot of consumer research and we’re trying to figure out what they want, what they’re looking for.
Dean Wehrli:
Any design thing you want to share with us beyond offices that might be something that you see as a trend?
Steve Hilton:
No, not really. I think we continue to focus on building a healthier home, of course, more energy efficient. That’s been our trademark for more than a decade now, but more healthy homes built with more sustainable materials. ESG is certainly a big deal in the public company space. So the environmental part of the ESG is important. We have a team of people that focus on that exclusively and keep your eye out for some announcements in the future on how our homes can become even more energy efficient, more healthy and more automated.
Dean Wehrli:
Whetting our appetite. I like that, all right. So things like energy, sustainability efficiency and healthy homes, those are here to stay. Do you think maybe there is a danger in the building community at large of maybe building to trends that are ephemeral, that might disappear fairly soon?
Steve Hilton:
I don’t think so. If you’re listening to your customers, you know what your customers value and what they’ll pay for. And if you put things in your home that you think are trendy or you think are cool and your customers don’t value them like you value them, you’re just given away your profits. So we’re very careful about even putting in a $50 item or a $100 dollar item into a home because you build 10,000, 15,000 homes, that’s a lot of money. So we consumer test every single thing that we put into our home to make sure that our customers believe there’s value there.
Dean Wehrli:
How about sales and marketing shifts? You mentioned ago about virtuality and how that’s taken over. I know your internet traffic is soaring as is true with just about every builder. Are we going to be permanently in this more virtual world, even more internet oriented than previously?
Steve Hilton:
I think it’s here to stay. We had over a million hits store website last two months. It’s been record for us, and I think a lot of the virtual tools that we’re using are here to stay. You need to get your mortgage online. There’s so many things, you can with DocuSign now, in a lot of places, you don’t have to go to the title company. There’s so much you can do now virtually that I think the entire experience is changing.
Dean Wehrli:
Are we going to see models maybe go away or be fewer of them and people do that virtually as well?
Steve Hilton:
Well, we’re already building less models because the visual offering, the visual presentation is so real today. We don’t need to build as many models. We can keep our marketing costs down. And when you’re an entry-level builder, you’re building the same product in many locations around the city. So we may not have it in this particular sub market, but we have the model in another sub market. And so we ask our customers to make a drive of 10 or 15 minutes away to see the model somewhere else if the model that we’re showing is not interesting to them. Also, when you’re building a 100% spec, you’ve got a lot of field models. We have a lot of products in the field that our customers can tour. So the combination of all those strategies allows us to reduce our marketing expense and to offer the customer a lower price, a better value, and the combination of those things lets you win and that’s what we’re trying to do.
Dean Wehrli:
I was going to wrap up by asking you, putting you on the spot kind of – Is there something that you guys are going to do that you think is going to make a splash in the near future?
Steve Hilton:
We’re just innovation all the time that we’re focused on. I can’t tell you there’s something imminently coming, but it’s about executing in this market. We’re in a fantastic market right now. I think it’s going to be around for a while, and it’s about sticking to the playbook and executing the strategy and building upon our culture and in a winning and creating value for our shareholders because that’s who we work for at the end of the day. And I’ve been in this business for 35 years, we’re celebrating our 35th anniversary this year. Actually I’ve been in the business longer than 35 years, but 35 years running Meritage. And I’ve never been more excited in spite of the kind of gloomy economic background that we’re looking and the COVID situation. I’ve never been more excited to be a home builder and to be in this industry than I am today, and it’s a great time to be delivering the American Dream. So I’m very optimistic about the future.
Dean Wehrli:
That’s a great place to end then Steve. I was going to ask you a question, but I think you just answered it on your own. We’re looking at a pretty healthy market here for a while to come.
Steve Hilton:
Thanks, Dean.
Dean Wehrli:
Awesome. Appreciate you coming onboard Steve.
Steve Hilton:
Okay. Do it again. Thank you very much.
Dean Wehrli:
Right on. Okay. That was New Home Insights Podcast. I’m your host Dean Wehrli with Steve Hilton of Meritage Homes. Listen next time.
