Major Homebuilders See Rising Orders but Shrinking Profits as Incentives Squeeze Margins

Major homebuilders are facing a tough contradiction, with orders rising but profits frequently shrinking as the use of price cuts and incentives cuts into margins.

In earnings reports this week, D.R. Horton and PulteGroup both showed the familiar split: Orders held up better than profits, while incentives and affordability pressure kept margins under strain.

D.R. Horton posted a drop in earnings and revenue, but said net sales orders rose 11%. Meanwhile, PulteGroup narrowly missed earnings per share estimates on a sharp decline in net income, but still grew net new orders 3%.

D.R. Horton CEO Paul Romanowski said on a call with investors that affordability challenges continue to loom over the market, forcing builders to offer generous incentives such as mortgage rate buydowns and closing cost contributions, in addition to outright price cuts.

“New-home demand remains impacted by affordability constraints and cautious consumer sentiment,” he said. “Our sales incentives increased during the second quarter, and we expect incentives to remain elevated for the rest of the year, with the level dependent on demand, mortgage interest rates, and other market conditions.”

Meanwhile, PulteGroup CEO Ryan Marshall had to explain to investors why the company's gross margin on home sales in the quarter was 24.4%, below Wall Street expectations and down from 27.5% a year ago.

"Our ability to offer low fixed-rate mortgages and other incentives is certainly helping solve the affordability riddle for some," he said. "But this comes at a price, as incentives in the quarter reached 10.9% of gross sales price."

For several years now, homebuilders have responded to sluggish buyer demand by ramping up incentives, with the rate buydown one of their most potent weapons in the age of elevated mortgage rates.

"The affordability crunch of this high mortgage rate market we've now been dealing with for several years is leading builders to offer serious incentives on homes they have for sale, whether that's price reductions, mortgage rate buydowns, or free upgrades to build-to-order homes," says Realtor.com® senior economist Joel Berner.

"Buyers are feeling skittish, and builders are willing to work with them to help them feel like they're getting a good deal on their new home," Berner explains. "But in order to stay in business, they have to make up the compressed margins on volume."

Many builders are choosing to sacrifice profits on individual homes for overall sales count growth, because homebuyers are currently hard to pin down, says Berner.

Marshall acknowledged PulteGroup is deliberately using incentives to preserve momentum.

“Our expectation is that we're going to continue to lean into the forward commitments,” he said, referring to rate buydowns and similar offers.

Still, deals offered by homebuilders probably won't last forever. For buyers, now is a great time to pounce on deals for new construction, says Berner.

"By being so elusive amid their affordability pressures, buyers have forced builders to offer them high volumes of buyer-friendly deals. When buyer confidence eventually returns, these incentives may be gone, so savvy buyers will snap them up while they can," the economist says.