Transcript
Dean Wehrli:
Hey, everyone. This is Dean Wehrli with the New Home Insights podcast. Today we have a heavyweight. Don’t deny it, Philippe, you are. On the other end of the mic here is Philippe Lord. He’s the CEO of Meritage Homes. Philippe, I feel like you’ve grown up with Meritage Homes and you’ve been hugely instrumental in building Meritage into, tell me if I’m wrong, but I believe the fifth-largest home builder by sales volume from 2022 in the country. Philippe, how you doing, and did I get that right?
Phillippe Lord:
Yeah. I’m doing great, Dean. Thanks for having me. I’m definitely not a heavyweight. I’m about 180 pounds.
Dean Wehrli:
Figuratively.
Phillippe Lord:
But I appreciate it. Definitely growing up with Meritage Homes, I’ve been with this company for over 15 years now. It’s really the only company I’ve worked for other than Centex when I first started out in home building, and I only did that for a couple of years and then went over to a land banker. This has really been my career. I’ve been really fortunate to have a unique opportunity to grow my career here. Started out in market research and land at corporate. Went over and ran the west region, had an opportunity to become the chief operating officer, and now I’ve been the chief executive officer for three years. There’s nothing I can’t tell you about Meritage, who we were, who we are, and who we plan to become. And I’m hoping to share that with you. We are the fifth-largest home builder as of last year based on closings. We’re really proud of that. What we’re most proud of is we did that organically. We didn’t go through acquisitions like a lot of other companies do.
We invested in our people, our strategy, our product, our culture, and grew this thing to the fifth-largest home builder. It’s one of the things we’re really proud of, creates a lot of connection throughout the organization and I’m excited to be here and excited to share the story.
Dean Wehrli:
We are too, and we’ll talk about that. A couple of the key things that enabled Meritage to be so big and they’re simple, but very elegant and very smart. In terms of what we’re going to talk about, so we’re going to start with something maybe a little inside baseball. Typically, on the show here, we talk about trends and I like to talk about what’s happening, what’s happening in the market, what kind trends, what kind of new things that are going on. Today we’re going to talk a little bit more internally, what your company philosophy and strategy is because I heard you talk about that recently. I found it really interesting, so I wanted to cover it here for a wider audience. Then we’ll get to those approaches that you do that enabled you to get big, things like efficiency, things like price attainability. And then if time permitting, we will maybe talk a little bit about how you see the market currently and going forward.
Let’s first do that. Let’s first talk about the company strategy. You folks follow something that, it’s one of those acronyms, I feel like you’ve heard it but maybe you don’t understand it that well, but it’s VUCA, V-U-C-A, volatility, uncertainty, complexity and ambiguity. Those are the things that make you work so hard and you tackle those considerations head on. Kind of just walk us through what those things mean and how it alters your approach or sort of guides how you run the company.
Phillippe Lord:
Sure. I’ve been the CEO for three years now, and when I became the CEO, we were in the middle of a pandemic. And so when I thought I was going to be creating plans for growth and business strategy and investing in our people and growing our talent base and solving affordability and et cetera, what I ended up doing for the first six months of my job was trying to keep people safe and healthy and supported in an environment where that was very difficult. As we got through that, we then went into a supply chain environment, which was very complex, very uncertain, ambiguous at times, complicated, et cetera. Navigating that external environment really challenged us as an organization. And then finally here we are today and interest rates doubled last year to the highest they’ve been in a long time and at the fastest pace ever in the history of rate volatility. And once again, creating a lot of uncertainty, a lot of ambiguity.
If anyone thought we’d be sitting here today selling the homes that we are as new home builders given what happened in the back half of last year, I’d like to meet that person and get their stock tips. But that’s really the context of what VUCA is, is the fact that we’re continuing to operate in an environment where things are constantly changing and we don’t know what’s around the corner and whatever is around, we probably don’t understand it and probably the playbooks of the past don’t really work today. And I think that’s happening for the world, not just for home builders. And so there’s been a lot written about that sort of the new normal is a state of volatility, uncertainty, complexity and ambiguity. And what do organizations need to do to lead in that environment? And I use the word lead because that’s less about execution, it’s less about strategy and navigation, and it’s more about how we show up as leaders when we don’t have all the answers and we don’t necessarily understand the problem. And what we spent a lot of time at Meritage focusing on is really a mindset.
Having a mindset as an organization, recognizing that we’re in this environment and the new normal is constantly a shifting sand environment. What do we need to do to support our people in that environment? And the first one is really having an agile mindset and it’s about being flexible, being nimble, being willing to let go of what you thought was the right answer and come up with the new right answer. And having no ego, having humility in doing that. I think a lot of times we think as leaders that we’re supposed to make a decision and stick to it because looking at us from that perspective, and I would just suggest that it’s okay to make a decision and then a little while later make a different decision and be humble about the fact that you didn’t have the same information when you made the first decision that you have now. We’re always trying to make the best decision with the best information that we have at the time.
Phillippe Lord:
Be willing to have an agile mindset and make sure your organization feels okay letting go, right? I really use that term letting go, let go of what we believed 60 days ago and let’s focus on what we know is today. No more can I make that point than what’s happened over the last four quarters. In the fourth quarter all we saw was cancellations. January wasn’t great, and then all of a sudden February we’re selling a bunch of houses and what did we not know? Well, we didn’t know that when interest rates doubled, they were going to lock in the used home market.
Dean Wehrli:
Yeah.
Phillippe Lord:
And now we have this new set of information, so what decisions do we need to make today? That’s really about having an agile mindset. The other one is an enterprise mindset, which is really focusing on we goals, not me goals. And getting your organization centered around what our shared sense of purpose is, what the overall strategy and goals are for the company and how we all connect to those goals versus thinking about our roles and responsibilities within a silo. When people are connecting to a broader vision and a broader strategy, I think that lends itself, again, to supporting having an agile mindset. We’re really trying to focus on what we’re trying to do as an enterprise and trying to get away from I’m the land acquisition person in Phoenix, I’m the purchasing leader in Charlotte, I’m the sales leader over here. No, we all work for Meritage. Here’s what Meritage is trying to do. We all contribute in a different way to that shared goal. And let’s connect on the shared goal versus just our individual goals.
Dean Wehrli:
Let’s come back to that in a second, Philippe, but I wanted to explore a little more about the nimble, the flexibility. When you approach it that way, are there any sort of, I don’t know for lack of a better term, like VUCA strategies or tactics, any kind of a playbook? Or is it literally more just you’ve got to be ready for change and have an openness to this change and pounce on it when it does happen?
Phillippe Lord:
Yeah. I would answer that two different ways. I think the playbook is a cultural playbook and it’s about… Let’s go back to the pandemic where none of us knew what we are dealing with there. What we did was we started having this meeting every morning at 9:00, and at first it was just myself at the other EVPs and we talked about what was happening. By day three, we realized we didn’t know what was happening and we didn’t have the right people at the table to give us the information so we could understand what was happening. We started inviting more people to the table. We invited some corporate leadership and we invited our regional presidents at the time that oversee large geographies for us. And then the meeting became more interesting because they were sharing information about what was happening at the field level with our folks, and then we were starting to make better decisions.
By the second week, we made the table even bigger and we invited all of our division presidents to that meeting. And literally every morning at 9:00, we had almost 50 of the top leadership folks throughout our company sitting at the table having an open dialogue, a psychologically safe dialogue about what was happening. And that’s when we started making really, really good decisions and we found ourselves being way more nimble and way more agile as the information was flowing in, our decisions happened a lot faster. What I would tell you is the playbook is make the table big, get the right people to the table and shut up and let them share information so you can make good decisions. We talk about diversity, equity, and inclusion, and this is the I, right? This is the I of that, which have a big table, have the people that are closest to the work sharing the information so you have the best information to make decisions, and then that’ll allow yourself to be agile and be nimble.
Dean Wehrli:
I love that phrase, have it be a safe space to speak and to say what you want. I know we’ve talked about, and a lot of companies think, okay, once a decision has been made, you want to be, what’s the dumb metaphor, pull in the same oar, that’s not it, rowing in the same direction, whatever that cliche is. You want to make sure the company is doing that, right? But at the same time, how do you balance that against the devil’s advocate to make sure people are willing to still say, I think we might be doing this wrong, here’s why, and not get punished for it.
Phillippe Lord:
Yeah. It’s about consequences drive behavior. When the person at the table is the naysayer or the antagonizer or the one who is questioning whether we’re even doing it the right way, first of all, I would tell you that as much as you think they’re a unicorn, there’s a lot of other people at the table who think exactly like them and want to ask the same question.
Dean Wehrli:
Yeah.
Phillippe Lord:
As a leader, I think it’s important to positively reinforce that behavior. Hey, we want people to come in and tell us are we doing this the right way. I heard that this might be a better way. I heard this from this person and this isn’t working. I know you guys think it is working, but it’s not working the way you think it’s working. And once people are willing to share that information, I think you want to reinforce that with a positive response. Other people feel like, oh wait, I saw Sarah. She raised her hand and brought up a pretty controversial topic and she was rewarded in that moment. Maybe this is okay to share that perspective. One of my favorite books of all times is a book called Team of Teams, and it’s by General McChrystal and it’s about the Iraqi war, and we were basically losing the war and it turned out that we were just moving way too slow because of the chain of command and they were doing all these raids on, excuse me, and they were really kind of kicking our butt.
And so he held a meeting and he brought all his main generals and he said, “Listen, I need to know what’s going on.” And he started asking questions and no one would answer because the chain of the command in the military is you never question your leader. And so he started having these meetings over and over again. He kept asking questions and no one answered. And he said he went through two weeks of having these meetings and no one said a word. And then finally this one general stood up and said something and he was like, tell me more, tell me more, tell me more, tell me more. And he really rewarded that general for being vulnerable, for sharing the information so that they could start making decisions. And then the other generals started speaking up. And then all of a sudden, this meeting became a collaborative meeting where diverse perspectives were rewarded, difference of opinions were okay, it was a very inclusive meeting. And then that changed the trajectory of the war. We started winning. And it’s a great book.
It’s called Team of Teams, and that’s kind of what I’m talking about. I mean, obviously we’re not fighting a war and we don’t have people’s lives on the line, although during COVID it kind of felt that way. But as we think about our business and we think about how uncertain and volatile and ambiguous and complex things are, the more you can empower the voice of the folks that are actually doing the work to help inform your decision making. And as a leadership team, the more agile and nimble you’ll be, and the more agility and nimbleness you have, the better you’ll be able to navigate complexity, ambiguity, volatility and uncertainty.
Dean Wehrli:
It’s hard though, isn’t it? I mean it’s easier to surround yourself with sycophants and wind up throwing away years of great brand awareness because you’re fixated on a certain letter of the alphabet, things like that. You can make a lot of mistakes if you don’t listen to folks, but it’s got to be psychologically hard though. You have to be able a lot of self-assurance to be able to listen to people who are saying you’re wrong, don’t you?
Phillippe Lord:
Oh, absolutely. And I think you got to, again, it’s a behavioral breakdown, right? It’s how you really want to show up. I think a lot of folks when they get to that corner office and you ask them how they got to the corner office, they say they worked really hard and they were comfortable making a tough decision. And I would say the work ethic matters, but enlightened leadership today, it’s more about surrounding yourself with the right people who are going to help you make the right decision. It’s not about you making the tough decision. It’s about collectively, let’s come together. Let’s get our perspectives to the table and let’s make the best decision at the time as a team with the information we have today. The other thing I wanted to share with you, because I told you I was going to answer that question in two different ways.
Dean Wehrli:
Okay.
Phillippe Lord:
I think your strategy is so important when you’re trying to navigate VUCA, because strategy to me is not just about your strategy, it’s about what you’ve chosen not to do as much as what you’ve chosen to do. At Meritage, we’ve chosen to focus on the entry level consumer and the affordable one MU consumer and the affordable empty nester. And we are really focused on affordability and we’re focused on efficiency, and we’re about delivering an easy, transparent home buying experience and a high quality, energy efficient home. And anything that I just said we are doing, we’re not doing, right? We say no to the luxury consumer.
Dean Wehrli:
Okay.
Phillippe Lord:
We say no to design studios because we build all specs.
Dean Wehrli:
Yeah.
Phillippe Lord:
We say no to land that doesn’t allow us to be affordable. We say no to product that doesn’t allow us to be affordable. We say no to trade partners that don’t allow us to be affordable. We’re saying no to a lot of things. And when you know what you’re saying no to, and then you are operating an environment where things are constantly changing, it’s a lot easier to lean into that uncertainty and the areas of uncertainty you want to lean into when you have a sort of a clear narrow focus of what you’re saying yes to. Unless the opportunities of change support your strategy, maybe it’s not for you. I think great companies, even companies like Apple and companies like Blue Cross and Tesla, they’re really good at navigating change, but one of the reasons they’re really good at navigating change is they’ve made some clear choices on who they want to be in the market.
Dean Wehrli:
Yeah. Almost this is the kind of strategy wouldn’t work for a company that is really diverse in terms of their endeavors and what they do and doesn’t have a fairly tight focus.
Phillippe Lord:
Yeah. I think if your strategy is I want to be everything to everybody, and I think if your strategy is I like shiny objects, I think it’s tough to navigate uncertainty and ambiguity and complexity.
Dean Wehrli:
Yeah.
Phillippe Lord:
I think it’s really tough.
Dean Wehrli:
I’ll ask you in a minute when we talk about the housing market how you see that playing out for housing as a whole of how are we going to be moving towards what Meritage is doing with a lot more companies? I think we are. But let’s switch over a little bit to now the second kind of module, which is sort of what Meritage does, what Meritage does really well and what has enabled it to growth. And you just hit it. It’s things like being super, super energy efficient and also being very attainable and affordable. Let’s start there. First couple of facts though, let’s do it. I think you’re going to close about somewhere in the 13,000 range of homes this year, calendar 2023?
Phillippe Lord:
Yeah. At our last earnings call we guided to right around 13,400.
Dean Wehrli:
And that’s going to be $6 billion with a B in total revenue, I think, right?
Phillippe Lord:
Yep.
Dean Wehrli:
And you’re pretty darn profitable, 24-ish return percent, something like that.
Phillippe Lord:
Our shareholders are happy.
Dean Wehrli:
Yes. Very much so. Let’s start with the product though. In terms of the product, you really are. You’re pretty much entirely and maybe absolutely 100% in the entry level space. I don’t know if you really do anything that people would consider move up anymore. You used to, and honestly you did it well, but you made a corporate decision a while back to be entry level. We’ve talked about this before and you’ve talked to this before, but just briefly, what were the key drivers that drove you to make that pretty consequential decision?
Phillippe Lord:
Well, I think we felt there was a couple of things. The first thing is we felt like affordability was the key. Although, we didn’t expect interest rates to stay as low as they did for as long as they did because we really pivoted in about 2016 was when we started this meaningful pivot to focus on affordability. We thought rates were going to go up earlier than they have. It took a pandemic, a supply chain shock, and now what’s going on right now for interest rates to finally go up and the Fed to start raising the rates. We felt as rates increased, affordability was the right part of the market to be in. We felt that if we built a really, really high quality home, not just one that was drive till you qualify, but built a quality home at an affordable price point, as interest rates rose, those folks would compromise the opportunity to sort of stylize and personalize your home for affordability.
And that was really sort of the macro thesis. As the millennials were coming into the market, as baby boomers were retiring, our consumer research told us that one of the reasons that they didn’t like buying a new home was because it was complex, it created anxiety, the bill times were long, the design studios were confusing. You didn’t know where your dollars were going, and what they really wanted was a high quality, affordable home. We decided to get away from customization and get into designing a high quality home that meets the needs of our consumer groups and make it as affordable as possible without compromising value in design. That’s number one.
Dean Wehrli:
Okay.
Phillippe Lord:
Number two was just the labor market. And I don’t personally see a path where all of a sudden there’s going to be a bunch of labor capacity to build homes. I think we need to figure out more efficient ways to build homes. I think we need to figure out ways to make our labor perform at a higher level, and I think we need to be innovative around how we’re building homes. And I don’t think you can do that if you offer customization and a million different permeations of your product. By streamlining our product, we already knew through the consumer research that the consumer wanted it, but we also felt that this was what the trades were going to want. And the more we could streamline our product, the more repeatable our product became, the more value engineered our product became, the more simple our product became, again, without compromising design and value, the better suited we would be to allow the labor to perform at a high level.
And also lending our business strategy to some of these building sciences and innovations that are occurring because it’s a lot easier to do offsite assembly when you’re only managing 300 floor plans versus 1,000 floor plans, plus all these different structural options and whatnot. By simplifying our business and streamlining it, we felt we would be able to innovate more as it relates to how we’re building homes and how we’re going to navigate the labor environment.
Dean Wehrli:
Costs are a big, big part, I mean, of attainability of price affordability. Obviously there’s regulatory hurdles, there’s land costs, et cetera, but how much of your business is offsite and panelized? And I’m going to ask you a follow-up, which is, why aren’t we, as a sector, seeing more of that?
Phillippe Lord:
Yeah. Not a lot of it is offsite assembly just because we’re still a ways away from those building sciences and innovations really lending itself to supporting the volume we do, right? When we’re building 14,000 houses, we just haven’t figured out how to scale that building science in a way where we can keep the machine going. We would have to get a lot smaller to start doing it. We already know it’s better, right, in a lot of ways. It’s better because I think the quality’s better, the efficiency’s there, it’s better because you move the labor indoors versus outdoors.
Dean Wehrli:
Yeah.
Phillippe Lord:
There’s less waste, but it’s still hasn’t become faster and still not as cost-effective.
Dean Wehrli:
Okay.
Phillippe Lord:
We can’t do it if ultimately it’s going to affect the affordability calculation. If we slow down or it’s more expensive, then we’re not affordable anymore, and so we got to stay affordable. Until we solve integrating those building sciences in a way where we can do that volume and still keep our costs low, it just doesn’t work for us. And I think that’s why things haven’t happened yet.
Dean Wehrli:
Yeah.
Phillippe Lord:
There’s that reason. And then finally, no matter how streamlined and efficient we make our product, the cities do the opposite. And so the municipalities are still making our product more complex than it needs to be with elevations and design requirements and et cetera. Because the cities all sort of have a different color of the rainbow they want, it’s really hard to make our stuff as repeatable and predictable as it needs to be to really allow those building sciences to work as effectively as they should. I really think that build for rent is the key to this whole thing. I think the build for rent organizations out there are going to solve this before we do because their product is even more repeatable and predictable than ours. It’s also smaller. They’re building 600, 800, 1,000 foot horizontal apartments, which really lends itself, in my opinion, to taking something inside a factory. I would look to them to see them actually be the pioneers here, and then I think once they figure it out, we’re going to be able to scale it up into the home builder space.
Dean Wehrli:
That’s interesting because it does seem like a catch 22. We know it works better, but it needs size and scope for it to be more affordable. The problem is the demand allowing that sector to get to that size and scope needs that answer to already be done. But you’re right, if BTR and other rental companies are able to push up the size and scope of that offsite construction, then the for sale folks can take advantage of that.
Phillippe Lord:
Yeah. I mean, some of these things, they need to be seated by a particular business profile, and I think build for rent probably can figure it out.
Dean Wehrli:
Have you thought about 3D building?
Phillippe Lord:
Yeah. I mean, we think about it, we explore it, we go out and look at where it’s being done and how it’s being done and how it’s being executed on. I think it’s super interesting, but I think it’s a long ways away. I think there’s a consumer perception of a 3D built home. I think consumers look at it and they don’t think it’s built the same way non-3D homes are built and this is the biggest investment a consumer will ever make in his life.
Dean Wehrli:
Yeah.
Phillippe Lord:
And they’re putting a lot of their dollars and their life in the hands of that new home and they want to make sure it’s going to hold up in a hurricane and hot weather, and I just don’t think the consumer is convinced of it yet.
Dean Wehrli:
Yeah. It’s one thing to be an early adopter on a $1,000 cell phone as opposed to a $500,000 home. Yeah.
Phillippe Lord:
Yeah.
Dean Wehrli:
That’s very true. Okay. Let’s switch over to your other passion is, and kind of a similar story I’m going to ask you with is you were huge and you’re pioneering in zero net energy, and before that even energy efficiency. That decision wasn’t foisted upon you though, that was internal, that was a choice that you made. Same question, and you did it pretty early. Back when you started shifting to being energy efficient and being very mindful of sustainability and net-zero, what was pushing you internally to make that decision?
Phillippe Lord:
Just for the utmost integrity, I think we focus on energy efficiency.
Dean Wehrli:
Okay.
Phillippe Lord:
There’s other builders out there that are doing, in my opinion, a better job getting to net-zero than we are, but we’re just really focused on being energy efficient and it’s all built around a product called spray foam insulation. We do spray foam insulation across the country in every market, across every home. It’s a product where you spray the insulation in. It’s a foam product that expands and it’s different than the blown in bad insulation or whatnot. And our science tells us that it’s a much better product because it creates a tighter insulation. It’s kind of like living in an igloo. It’s so tight, less cold air and hot air exchange, less dust, less pollutants, less allergies. The home is just so airtight, and so it creates a much more insulated controlled environment that we think is just better.
It’s not only better for energy efficiency, but it’s better for the quality of living in the home. Why did we do it? Well during the great recession, as everyone’s research told them that 90, 95% of the homes being sold between 2008 and 2014 were used homes, and I think during that time it was over 90% and the new home construction was really having a tough time, and there was a lot of foreclosures and all that stuff. And we were trying to figure out how to compete with the used homes, and we didn’t think just being newer was effective. And so we felt like we had to be better. And so we focused on energy efficiency because we felt that that would make us better and it would allow us to compete against the used home market in a unique way versus just saying, we’re newer. Now, we could say we’re better and we could create dissatisfaction with your existing used home, right?
We’re always trying to solve that inflection between your current dissatisfaction with your current residents and the new satisfaction you’re looking for in your new residents. And we felt like this created an ability to do that and gave our sales team a tool that they didn’t have available before. And then lastly, and again, much like interest rates going up, it took a while for this to happen as well, but we read the tea leaves on code change and we just saw that the government was going to continue to regulate our industry and require us to continue to build our homes in a more energy efficient way with less carbon footprint.
Dean Wehrli:
Mm-hmm.
Phillippe Lord:
And so we felt like we needed to get ahead of that and recognizing that it also created a unique selling proposition and a differentiator in the market. That was really the genesis of the strategy.
Dean Wehrli:
We all have seen so many times that today’s innovation is tomorrow’s standard feature and everything people were saying, oh my gosh, about is like, oh, ho-hum. You better have that. How are you staying on top of that? Don’t you have a division that’s looking into home science and trying to just be as innovative as possible because that does separate you from the crowd?
Phillippe Lord:
Yeah. I mean, we’re definitely a company that balances out centralization and decentralization. We have a strong corporate group over here in Scottsdale, and a big part of our corporate group is they’re focused on innovation. You name it, all types of innovation, but specifically, we have a whole team here that’s locked in on product innovation, building science innovation, building process innovation, feature innovation, you name it, it’s all they do. This is what they jobs are is to study the environment, the market research, et cetera, to bring forth ideas around how we can innovate. I’ll go back to something I said earlier, but we only want to innovate if it supports our strategy.
Dean Wehrli:
Okay.
Phillippe Lord:
That allows us to filter the opportunities to change very quickly, right? The analogy I’ll use is if you’ve ever stayed in New York or San Francisco and you’re up in the middle of the night and you look out your window and you see a skyscraper next to you and there’s a bunch of lights on. And all those lights represent an opportunity for change, but you can’t go through all the windows, you can only go through a few because you only have so many capabilities. Well, how do you decide what windows you want to go through? And that goes back to your strategy. If it doesn’t support being affordable, if it doesn’t support being attainable and it doesn’t support being accessible, well, we don’t want to do it.
Dean Wehrli:
Okay. You have these two huge twin goals and really achievements. You’re very affordable and price attainable. You’re also very efficient and very smart homes. Pretend you have this horrible Sophie’s Choice nightmare world where you had to make a decision between the two of those, which would you fudge toward the attainability or fudge towards maintaining the efficiency, et cetera? Horrible question, I know, but I have to ask.
Phillippe Lord:
No, no. I feel like you could actually come work for us. We literally ask that question, it feels like, every year. We have no sacred cows here. At the end of the day, the most important thing for us is to provide a high quality home at an affordable price point.
Dean Wehrli:
Okay.
Phillippe Lord:
Everything else is on the table. Now the question is, is energy efficiency a more important component of high quality or is features and design?
Dean Wehrli:
Mm-hmm.
Phillippe Lord:
We’re constantly struggling over those two ideas and trying to figure out the right goldilocks scenario for us.
Dean Wehrli:
Yeah.
Phillippe Lord:
For now, we’ve been able to figure out how to do both. And I think when you have a narrow focus and you have a clear strategy, you get really good at what you’ve chosen to focus on. And we’ve gotten really good at being able to be affordable and attainable while still providing that energy efficiency and also not compromising on quality and design. We’re constantly working that game theory formula, Dean, and every year I feel like stuff’s on the table and we’re kind of contemplating what we do to be as affordable as we can. I would also say we keep using affordable, attainable, accessible. Affordable, to me, is about the price, okay. At the end of the day, there’s a lot more people that can afford a $2,000 payment a month than a $3,000 payment. We want to be affordable. Attainable, for us, is really about our spec strategy, which is when someone wants to move and they need to move, do we have product they can move into?
Dean Wehrli:
Gotcha.
Phillippe Lord:
Versus waiting six, nine months for the house to be built. We’re really focused on building specs at Meritage Homes because we want to be attainable, meaning that when that person, especially like you think about right now with rates doing what they’re doing, when that person wants to move and they know their payment and they got their rate locked in, can we get them in their home in the next 30 or 60 days? And that’s that attainability.
Dean Wehrli:
Okay.
Phillippe Lord:
And then accessibility is actually about our marketing and sales strategy, which is really about meeting people where they are, when they want our product to be accessible. We allow people to tour our homes on their own, right? People can go and they can schedule an appointment. They can go walk at one of our models or walk one of our specs and they can do it on their own because maybe they want to go look at it at 10:00 at night because they’re working late or whatever. We’re trying to make our product more accessible to our consumer through our sales and marketing strategies.
Dean Wehrli:
I think that’s key. I love the idea. I’ve been saying that honestly for years and years and years and years, 9:00 to 5:00 during the weekday is completely senseless, but at the same time, I wonder if a completely non-touch, non-interactive experience is what everybody wants. It’s kind of that offsite versus onsite sales in the rental world is a big debate within leasing as well. Do you see yourself moving towards more of a completely offsite sales experience?
Phillippe Lord:
Sure. I mean, look, I think that diversity is the name of the game when it comes to the consumers. I think people are just wired differently.
Dean Wehrli:
Mm-hmm.
Phillippe Lord:
We say millennials and we try to index millennials to certain behavioral patterns, but at the end of the day, there’s 80 million of these folks. They all have different upbringings and experiences and lives, and so they want to engage with our product in a different way. And we want to be available and allow them to engage with our product in the way that they want to engage with it, right? I think when it comes to consumer engagement, you want to be very diverse and you want to meet people where they are. Just forcing a square peg into a circle hole when it comes to consumer engagement, to me, is a missed opportunity.
Dean Wehrli:
Yeah. And there is kind of a demographic overlay, isn’t there? I moderated a panel on offsite versus onsite leasing debate, and the person who was doing more offsite said, “Look, we have lots of younger renters. They don’t want to interact with a human. They want to point and click experience.” They preferred that offsite experience even if your strategy was to be on onsite.
Phillippe Lord:
Yeah. And you look at the used home market, things are a little skewed right now. I think new home market share is north of 35% right now because the used home market is locked up. But when it’s not locked up, there’s lots of different ways for realtors to engage with the existing home market and get their consumers engaged with that product. I think at least at Meritage, we want to start to feel and look more like the existing home market when it comes to consumer engagement because we want to stay in the largest consideration bandwidth we possibly can. We want to be considered by as many people out there as possible who are looking for a high quality affordable home.
Dean Wehrli:
That’s a great segue. Let’s switch over now to the market and a couple of questions along that line before we let you go. The first one actually literally was that, I swear to you, I’m looking at my questions right now in terms of market share, the new home market share has surged now as they’ve had these golden handcuffs, have kept a lot more folks in the existing home world in their current home. How do you see that playing out? How long does the new home sector maintain that share? How do you see that going?
Phillippe Lord:
Yeah. And I think it’s important to frame this the right way. I mean, new home market share has surged, but it’s not like the whole market, we’re building more homes this year than we built last year. In fact, I think we’re building less.
Dean Wehrli:
It’s a smaller denominator.
Phillippe Lord:
Exactly. That’s exactly right. It’s just that the existing home market is locked up.
Dean Wehrli:
Yeah.
Phillippe Lord:
I’m not an interest rate forecaster. There was a gentleman at the John Burns conference who that was his job and I was paying attention. I’ll leave interest rate forecasting to them, but the forecast I’m reading is that it’s going to stay higher for longer.
Dean Wehrli:
Yeah.
Phillippe Lord:
And so I think if rates stay higher for longer, then that new home market share is going to stay elevated, because for all the reasons we’ve talked about, which is people are just going to stay put and deal with whatever their current residence is or remodel it versus selling it, cashing out on some equity and go and buy another home and taking on a big expensive mortgage. I think rates stay elevated, and I think therefore the new home market has an elevated market share for the foreseeable future.
Dean Wehrli:
But you’re facing that same issue, right? It also eats into your demand by having these folks who can’t be contingent, can’t sell their home, can’t tap into their equity because of the higher mortgage rates. Do you find yourself now consciously marketing toward those households that are for some reason kind of more motivated to move like new households or relocations or growing or shrinking households? Is that more of your target buyers now because of those golden handcuffs?
Phillippe Lord:
Well, I mean, most of our buyers are first time entry level.
Dean Wehrli:
Yeah.
Phillippe Lord:
They’re just coming out of an apartment or living with their parents, and so that stuff’s still happening. And so their calculus is very different than the calculus of someone who’s currently living in a home, because they got to do the math on, okay, I have a rate at 3% and now I’m going to take on a rate at five and half or 6%. Yeah, I’ll put this cash in here and et cetera, et cetera. Someone who’s living with their parent, someone who just got married, someone who’s living in an apartment, someone who just got promoted, it’s just about a payment. Can they justify the payment to get in the home they want? And I guess what we’re seeing as we always knew that even at elevated rates, there’s housing demand.
Dean Wehrli:
Mm-hmm.
Phillippe Lord:
And with the existing home market being relatively non-existent, that housing demand is coming to the new home market and we’re affordable. I don’t think we’re changing the way we’re marketing.
Dean Wehrli:
Okay.
Phillippe Lord:
We’re just seeing more of those folks that would’ve normally bought a used home are now buying from us.
Dean Wehrli:
Okay. Yeah, because if you’re entry level focus, that’s a good point. You’re not as potentially impacted as someone who might be in the second move up with those buyers needing that equity, right?
Phillippe Lord:
Yeah.
Dean Wehrli:
Okay.
Phillippe Lord:
We always ask our consumers, we always ask them, “Hey, where were you looking? How’d you find us?” And we’re seeing a lot more people who were looking in the used home market and basically told us they couldn’t find anything. Now they came to us. If there was product on the used home market, they would’ve actually bought a used home, which is crazy because I don’t know why you’d want to buy a used home over a new home, probably location, school district, things like that.
Dean Wehrli:
Or price, right? There’s always just a perception it must be cheaper, right? Right?
Phillippe Lord:
But the delta between used and new is not that much these days.
Dean Wehrli:
Yeah.
Phillippe Lord:
In fact, existing homes are really elevated. We’re fortunate right now because a lot of folks that probably traditionally would’ve bought a used home are buying from us.
Dean Wehrli:
Are you in growth mode? Are you looking at new markets? Are you looking at expanding in markets? Are you still in that phase?
Phillippe Lord:
We are, but in the last three years, we just went into four new markets. We went into Charleston, Myrtle Beach, we went into Jacksonville, and we went into Salt Lake City. We’re getting those going. Things are going great. We’re building out those businesses, we’re getting scale. There’s a lot of opportunity for us there to grow. We’re going to continue to grow in our existing markets because I think there’s a lot of existing markets where we can get a lot bigger. We want to be a lot bigger in Florida, a lot bigger in Texas than we are. And then we got these three new markets that we’re growing into. We got a lot of opportunity to grow. We just got to get the land, get the land.
Dean Wehrli:
I’m going to ask you a land question in just a second, but first real quick, this is going to be a weird question, but do you have an assumption that you’re going to absorb given neighborhoods all at once, say four homes a month, or do you still allow for some price sales elasticity in the market if you do have say, multiple product types in a master plan and some are priced above the other? Does that make sense?
Phillippe Lord:
Yeah, it makes sense. We have a pretty narrow strategy. We are mostly focused on affordable kind of entry level and then a little bit of affordable move up. And so, we think we should be doing four to five a month at the affordable entry level price point. That’s kind of how we underwrite land. And then we think we can do four to three a month on the affordable one MU. When you blend that all out, we like to see three and a half to four a month across our portfolio, our total business, and we buy land based on that assumption
Dean Wehrli:
In terms of buying land, okay. You guys own a lot over your land, don’t you? I mean, you still do some land banking. I think you still do options, but you own a lot more relative to other publics, I think. Tell me if I’m wrong, you own a little bit more of the share of your land. What’s behind that strategy?
Phillippe Lord:
Yeah, no, you’re not wrong. We’re a bit of an outlier. I think the why behind that is, number one, we have a great balance sheet. We have $1.2 billion of liquid cash. We have another 800 million in a revolver. Our net debt to cap ratio is in the negatives. We don’t see a reason right now to secure off balance sheet financing that’s expensive when our cost of capital is super cheap. Until we get to a point where our balance sheet can’t drive the growth we’re looking for, we don’t feel like off balance sheet financing makes sense. The second reason is land banking has really changed since the last recession, and land bankers are much more risk-adverse, and so the structure of the deals and the type of deals they’re willing to land bank tend to be the best deals in the basket.
Dean Wehrli:
Okay.
Phillippe Lord:
And so you’re no longer displacing risk. You’re putting your best assets there with the best margins, and you’re basically driving the margins down on your best assets and giving them to the land banker. Again, unless your balance sheet is stretched too far, we don’t really see a reason to do it.
Dean Wehrli:
Okay. You might be more willing to land bank on, for lack of a better term, a sea location, but you might not find the appetite out there among land bankers to do so?
Phillippe Lord:
Yeah. I just think not necessarily sea location, but I just don’t want to take all my highest margin deals and land bank them. It’s not necessarily about the quality of the location. It’s kind of about the quality of the land buy, and I don’t want to take all my high quality land buys that I know I’m going to make really good margins on and necessarily land bank those.
Dean Wehrli:
Okay. Are you willing to take entitlement risk for if the deal’s right, if the place is right? No?
Phillippe Lord:
No.
Dean Wehrli:
Okay.
Phillippe Lord:
No, we won’t close anything without fully vested entitlements.
Dean Wehrli:
Okay. Okay. You mentioned the BTR space. I want to have a couple more questions. One is on build to rent. You’re entering the build to rent market in a big way, pretty gung ho about that. Looking forward to that, still on the upswing?
Phillippe Lord:
Yeah. I mean, we’re not in a big way. We imagine it over time to be about 10 to 15% of our business, but we’re not even close to getting there. We’re really structuring it in a way that we think it’s complimentary to our business, not a separate business channel. We already build affordable entry level product that’s tends to be two bathroom, three bedroom, three bedroom, three bath, four bedroom two, which is the configurations that really the single family rental consumer is looking for. We’re trying to really leverage our existing business strategy into that channel, and we’re just trying to figure that out. I think we’ve done a little bit of it over the last two years. We have some strategic partnerships out there that we’re working with to really drive our long-term goal, but it’s slow-going.
Dean Wehrli:
Well, one more question before we will wrap it up with your crystal ball a little bit. It is the age qualified space. What’s your take on that 55 plus for sale space?
Phillippe Lord:
Well, I think it’s a huge consumer group, especially in the markets we’re in, which is the Southern Hemisphere. And I think also they’re looking for affordability. We don’t really create what we call age targeted communities, but we do have a lot of age targeted product in our portfolio. We build a lot of single story, a lot of homes that have nice outdoor living spaces, things that consumer’s looking for, but we don’t necessarily target at the community level. We just target it with our product and we see a lot of those consumers buying our product, but we’re not in the, we’re going to build out a community that only allows 55 or plus consumers, the active adult business, if you will, that I think Pulte and Taylor Morrison do a really great job with.
Dean Wehrli:
And Toll Brothers too. Age targeted, you build the right product to capture those folks in your Phoenix and Southern California and Florida spaces, but not the classic 55 plus. Okay.
Phillippe Lord:
Right.
Dean Wehrli:
We’re going to end on two. Kind of flip of the coin, flip of the same side questions, which is one, and I think I know the answer to this, but right now, what is the greatest advantage for the new home sector? Is it just this really, really hyper limited resale sector or something else?
Phillippe Lord:
No, I mean, I think that’s definitely externally creating the opportunity for us, but the advantage I think we have is the fact that we have the ability to create product that the consumers are looking for and solve for their payment in a way that the used home market can’t solve. A lot of us have mortgage companies or JVs with mortgage companies, and we’re able to get really creative on putting you into a financial vehicle that really makes sense for you and can help you get into the home. The used home market just really don’t have the tools that we have. I think rate buy downs and creative financing is really a tool that all of us have that’s creating a big advantage right now. And then just being able to design homes the right way versus going, buying a used home and you kind of get what you get.
Dean Wehrli:
It’s funny, you mentioned that you were a little surprised how many people are so willing or they’ve kind of pre-decided to buy an existing home, a used home, and whereas they can get a very affordable new home from you. Once there is more inventory and resale, will you still kind of go after those folks? Will you try to market more so to them specifically to say, look, you’ve got a new option that you may not have considered?
Phillippe Lord:
Yeah, I think you nailed it. I think it’s a big opportunity. You’ve got to scratch your head on why so many people choose to buy a used home over a new home. And I think it goes back to trust, transparency. There’s a perception that when you buy a new home, you don’t know when it’s going to get built. You don’t know if it’s going to be on time, is it going to be built the right way? There’s a lot of anxiety and stress that comes with that process. I think people feel like the used home market is easier to engage with than the new home market. And I think that drives that compromise because it’s a compromise. I mean, when you buy a used home, you’re getting a used home. When you buy a new home, you’re getting a new home and it’s much better and you get it the way you want. I think there’s a lot of people that are willing to make that compromise because the perception is that buying a new home is a real stressful and challenging process.
Dean Wehrli:
Now, the flip of that coin is what is the greatest challenge right now for new homes, for the market?
Phillippe Lord:
Yeah. I mean, I don’t want to phone in the answer, but it is what it is. I think obviously interest rate volatility continues to be a challenge.
Dean Wehrli:
Yeah.
Phillippe Lord:
Still a lot of uncertainty around where rates are going to settle in at and how. I think the supply chain problems aren’t going away. In fact, I bet we start to hear more about the supply chain challenges once again as all of us are ramping up production again, and I just think that there’s a finite capacity to the supply chain. I’m hoping that with less commercial and industrial construction going on, maybe there’s some more capacity for the new home and residential construction, but I think the supply chain’s going to be challenging. And then finally, I don’t know about you, but it’s not getting any easier to hire, retain, motivate, and engage the talent out there. The talent really has choice. They are choosing to work for you. You’re not choosing to let them work for you. And finding ways to connect with that talent, to develop them, engage them, inspire them, motivate them is something that always needs to be front and center and a challenge of the future.
Dean Wehrli:
Yeah. No, all those make sense. And sometimes, in fact, probably the majority of the time, the “obvious answer” is usually the right answer. I think in this case, mortgage rates, if I had to pick one, honestly, I think I’d pick mortgage rates because it is not just high, but like you said, it’s volatile. Folks don’t know what’s going to happen next and that sometimes can freeze them.
Phillippe Lord:
Yep. I think that’s right.
Dean Wehrli:
Philippe, I really thank you for coming on. This has been fantastic. We covered everything I wanted to cover. I’m so happy we did that. Thank you so much.
Phillippe Lord:
Yeah, no, thanks for having me. I really, really appreciate it.
Dean Wehrli:
Absolutely. This has been Dean Wehrli for the New Home Insights podcast. We’ll see you again in a couple of weeks.
