Toll Brothers

Toll Brothers posted strong results this quarter despite a challenging housing market backdrop. Revenues were in line with guidance at $2.6 billion while adjusted gross margins slightly beat expectations, largely due to lower incentives and flat building costs.

Why it matters: Economic uncertainty and geopolitical tensions have pushed mortgage rates up and have tested housing demand. Despite this, Toll Brothers' profitability has held up relatively well and has continued to materially outperform peers. The firm's higher income customers are much more resilient to swings in mortgage rates. This is evident from the fact that about a quarter of the homes sold by the company are all-cash transactions and the average loan-to-value on the remaining homes is about 70%. Management indicated that incentives reduced 50 basis points over the quarter while pricing improved. Toll Brothers slightly raised its full-year guidance on home deliveries, meanwhile both D.R. Horton and Lennar have lowered guidance for full-year closings.

The bottom line: We have increased our fair value to $152 from $147, mostly due to time-value of money and changes in our near-term margin forecasts. Our long-term outlook remains unchanged, and we see shares fairly valued on a risk-adjusted basis. Since 2022, strength among higher-income households has helped Toll Brothers post solid gross margins, outperforming D.R. Horton and Lennar by over 300 basis points on unadjusted metrics. Our outlook on housing starts remains constructive and we expect industry demand to rebound beyond 2027 as macroeconomic uncertainty eases and mortgage rates decline.

Long view: We forecast roughly 26%-27% adjusted gross margins (excluding interest and inventory impairments) in the near term, but our long-term mid-cycle estimate is around 25.0%-25.5% as we expect the unique factors benefiting the luxury housing market to weaken over time.

BLANK PAGEAccording to the national association of realtors, middle income households can only afford 23% of listings nationwide. The US housing market is structurally undersupplied, and we expect affordability to stay a key theme over the long-term. With over 60% of the Toll Brother's sales coming from its core luxury offering, the firm is primarily exposed to the highest income households. As per recent data, highest income households in the US (top 1%) have grown their income substantially faster than the population. The affordability concern impacting the broader homebuilding space is much less of a concern for Toll Brother's luxury focused buyers due to their higher income levels, substantial existing home equity (for move-up buyers), and wealth effect emanating from buoyant stock portfolios.

Interestingly, management was asked about more of the firm's peers moving into the build-to-order and higher price point segments, given the resiliency of higher income households. We agree with managements comments that Toll Brother's is much better positioned to serve this end of the market given its focus on customization (through its 45+ design studios) and a land portfolio that is oriented towards the luxury product.

We assign Toll Brothers a fair value estimate of $152 per share. Our fair value estimate is about 11.5 times our earnings estimate for 2027 and 1.5 times our tangible book value estimate for 2027. We note that forward earnings multiples for the firm has benefited because of greater margin resilience in recent years compared with other homebuilders. Our weighted average cost of capital for the firm is 9.7% based on a cost of equity of 10.3%, a 25.5% long-term tax rate, and a 90% equity weighting.

Our revenue growth projections are based on our US housing demand forecast, along with assumptions about Toll Brothers’ market share and average selling price. We forecast Toll Brothers to increase consolidated homebuilding revenue at about a 5% compound annual growth rate through 2035. We expect single-family housing starts to rebound to over 1.1 million units by 2029, as the housing market recovers, and to remain above 1.05 million units on a midcycle basis. We expect Toll Brothers to continue gaining market share and project its share of home sales to reach around 2.1% by 2035 from 1.7% in 2025. This results in a 3.5% CAGR for homes closed over the next decade. We assume roughly 1.5% ASP growth through 2035 (compared with 2025) due to a mix shift toward the firm’s more-affordable product offerings and moderating homebuilder pricing power over the long term.

Many builders have resorted to sales incentives, primarily mortgage rate buydowns, to convince skittish buyers to purchase new homes, and some builders have also reduced base home prices. While these actions may buoy the sales pace, they also reduce profit margins. Toll Brothers has largely chosen to maintain its pricing, even if new order volume shrinks as a result. This strategy has led to more resilient gross profit margins for the firm relative to many of its public homebuilding peers.

Toll Brothers enjoyed robust pricing power in 2022-24, with home sales adjusted gross margin (including interest expenses) averaging above 26.5%, compared with 22% on average between 2014 and 2021. In 2025, Toll Brothers increased its sales incentives and speculative home deliveries, which slightly compressed adjusted gross margins to 26%. We expect this trend to continue over the next two years as the US housing market remains slow and Toll Brothers tries to attract more buyers. As such, we model home sales adjusted gross margin to slip to around 25% in 2026-27. We model a midcycle gross margin of about 24%, which we think accounts for eventual increased competition from the resale market, risks tied to Toll’s more speculative building strategy, and broader industry competition and cyclicality.

We project that selling, general, and administrative expenses as a percentage of home sales will increase 60 basis points in 2026 (to 10.1%) due to less operating leverage, and we forecast SG&A expense as a percentage of home sales to be in the 10.0%-10.5% range in fiscal 2026-27. Over the long run, we expect revenue growth and more efficient homebuilding operations to unlock modest operating leverage, reducing SG&A expense as a percentage of home sales. We model Toll Brothers' SG&A ratio moderating to 9.7% on a midcycle basis, and averaging at 10% over the next 10 years.

Our assumptions for inventory as a percentage of home sales reflect our belief that, while Toll Brothers can improve its inventory efficiency relative to history, its luxury strategy will continue to result in higher inventory/home sales ratios than some other public homebuilders. As such, we model a 10-year average inventory/sales ratio of 98%. Nevertheless, this 10-year average is still a significant improvement for Toll Brothers; we calculate that this ratio was over 150% as early as 2015 and near 110% in 2018-20.

We use a three-stage DCF model for valuation, with the first stage being explicit forecast years. The second- and third-stage assumptions in our DCF model imply a terminal EV/EBITDA multiple of 7.7 times.

We assign a no-moat rating to Toll Brothers as we believe the firm has limited benefits from its scale and luxury brand, and has no significant cost advantages. US homebuilders operate in a highly cyclical, competitive, and capital-intensive industry, making it challenging to earn consistent economic profits over the business cycle. The market has been consolidating but remains highly fragmented with intense competition. Homebuyers looking for new homes in a specific market have many options to choose from, and pricing is often the primary lever for their decisions. The industry is characterized by a lack of sustained product differentiation, resulting in minimal pricing power for homebuilders. Due to this dynamic, brand loyalty among homebuyers is virtually nonexistent, leading to homebuying decisions being highly price-sensitive. Scale-based cost advantage is the most relevant moat source in the homebuilding industry. Large homebuilders have an advantage over small-scale builders in their ability to acquire regional builders and quickly capture market share. However, we believe the market, especially in densely populated metropolitan areas, is largely saturated, which will make it harder for builders to increase their market share as quickly in the future.

Industry Dynamics: America's homebuilding industry remains highly fragmented despite considerable consolidation in the past four decades. This fragmentation is driven by the highly local nature of residential construction, where homebuilders must respond to local demand and supply while also navigating complex zoning ordinances, land-use regulations, and building codes. The industry’s low barriers to entry allow thousands of small homebuilders to compete in the US.

Lack of Pricing Power: Due to the highly competitive environment, we believe homebuilders lack significant pricing power. Even for Toll Brothers, which prides itself on being a luxury brand, home prices have largely adjusted in line with the market. Toll Brothers can charge more for its homes on average due to a higher-end offering, but we think costs for these homes are also higher, and we do not think margins reflect significant pricing power. While Toll Brothers’ higher-income consumers are generally more resilient during downturns, the firm still relies on sales incentives to maintain volume. We believe Toll Brothers’ lack of pricing power stems from the product being largely undifferentiated. We see location, quality, and pricing as critical drivers for consumers. The firm’s competitors can also enter new markets and replicate successful product and land acquisition strategies with relative ease, potentially diminishing returns for incumbents. We see few barriers preventing builders from replicating successful product and land acquisition strategies, especially for public companies with the scale, experience, and capital availability to do so.

Cyclicality: The homebuilding industry is highly cyclical, with economic downturns driving significant slowdowns in housing starts. During downturns, smaller homebuilders that do not have strong relationships with banks can feel significant pressure when demand for housing decreases. In response, many of these small firms may trigger price wars to drive up volume, despite suffering poorer margins. Due to the lack of pricing power across the industry, these price wars can exacerbate downcycles even for the largest of homebuilders. On the other hand, during good times, low barriers to entry can fuel the inflow of new entrants when returns are high, thereby lowering returns across the industry.

Land Light Strategy: Homebuilders have been moving toward controlling land through options contracts that grant homebuilders the right, but generally not the obligation, to purchase land at a specified price on a future date. While these contracts boost ROICs, the option contracts charge a premium over the underlying asset, and therefore, the cost of acquisition, on average, is expected to be higher than buying raw land itself. Land optioning reduces outsize cyclical downside risks, provides better capital efficiency, and improves free cash flow conversion, but this strategy can result in margin compression, assuming everything else is equal.

Scale: We believe that the decentralized structure of the industry, across both small and large firms, makes it challenging to gain any cost advantage. Toll Brothers, despite its scale, hires subcontractors to manage local building operations. The market for subcontractors is highly competitive due to low barriers to entry, and subcontractors are often selected by homebuilders through a bidding process. Additionally, scale does not have a material influence on the cost of land acquired by homebuilders. We believe larger homebuilders do gain from volume discounts on materials such as timber, concrete, and home appliances, but we also think that most publicly listed builders benefit from similar discounts, preventing large players like Toll Brothers from gaining any advantage. Overall, these arguments, regarding both labor and material costs, explain why size shows little correlation with margins within the homebuilding industry.

We do not have confidence in the firm's ability to generate excess returns over the next 10 years, given the current industry dynamics. The industry has consolidated significantly over the past few decades, and the competitive positioning of the largest players in the industry has improved on a relative basis, but the core characteristics of the industry remain unconducive to moats. Toll Brothers’ scale will benefit the company over the next decade, and we expect the firm to continue gaining market share, but we would like to see significantly more consolidation and stronger evidence of volume-based scale advantages before we reconsider our moat rating.

The housing supply/demand imbalance will take years to address and should support homebuilders' pricing power.

Toll Brothers’ targeted customers are wealthier, have stronger credit profiles, and are more likely to make all-cash payments than the typical homebuyer. As such, interest rates are less of a factor for the company's customers.

Toll Brothers' strategic shift toward more-affordable home designs and geographies and its greater production of spec homes should expand its customer base, supporting stronger growth.

High home prices, elevated interest rates, and economic uncertainty could cause a prolonged slowdown in US housing demand. Muted demand, along with elevated new homes inventory, can lead to significant margin pressure.

Constrained land supply and rising labor and material costs could limit Toll Brothers' production and/or profitability on delivered homes.

As a luxury-focused homebuilder, Toll is not well-positioned in the fast-growing entry-level market.