LGI Homes (LGIH) Q3 2024 Earnings Call Transcript

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LGI Homes (NASDAQ: LGIH)
Q3 2024 Earnings Call
Nov 05, 2024, 12:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to LGI Homes third quarter 2024 conference call. Today's call is being recorded, and a replay will be available on the company's website at www.lgihomes.com. After management's prepared remarks, there will be an opportunity to ask questions. At this time, I'll turn the call over to Joshua Fattor, executive vice president of investor relations and capital markets.

You may begin.

Josh Fattor -- Vice President, Investor Relations

Thanks, Latania, and good afternoon. Before we begin, I'll remind listeners that this call contains forward-looking statements, including management's views on the company's business strategy, outlook, plans, objectives, and guidance for future periods. Such statements reflect management's current expectations and involve assumptions and estimates that are subject to risks and uncertainties that could cause those expectations to prove to be incorrect. You should review our filings with the SEC for a discussion of the risks, uncertainties, and other factors that could cause actual results to differ from those presented today.

All forward-looking statements must be considered in light of those related risks, and you shouldn't place undue reliance on such statements, which reflect management's current viewpoints and are not guarantees of future performance. On this call, we'll discuss non-GAAP financial measures, which are not intended to be considered in isolation or as substitute for financial information presented in accordance with GAAP. Reconciliations of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be found in the press release we issued this morning and in our quarterly report on Form 10-Q for the quarter ended September 30, 2020, that we expect to file with the SEC later today. This filing will be accessible on the SEC's website and in the Investor Relations section of our website.

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With me today are Eric Lipar, LGI Homes' chief executive officer and chairman of the board; and Charles Merdian, chief financial officer and treasurer. I'll now turn the call over to Eric.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Thanks, Josh. Good afternoon, and welcome to LGI Homes earnings call. We're pleased to report another strong quarter, driven by sustained demand for new homes across the country. Despite continued affordability challenges, we delivered outstanding financial results that reflect our focus on operational excellence and a commitment to maximize profitability on every home sold.

As highlighted in our press release this morning, we delivered 1,757 homes in the third quarter. Those closings combined with a record-high ASP of more than $371,000 resulted in revenue of $652 million, an increase of 5.6% compared to last year and the highest revenue we've reported since the second quarter of 2022. For the last several years, we made considerable progress in acquiring and developing attractive land positions across the country. Over the last year, you've seen many of these communities come online, and we're extremely pleased to have ended the third quarter with 138 communities, a noteworthy 30% increase over the prior year and our sixth consecutive quarter of community count expansion.

Additionally, this was the largest absolute number of communities that we've added in any single year. Given when we acquired these communities, the capital invested in their development, and the rising cost of replacement projects, their inherent value is substantial. In light of this, simply maximizing absorptions at the expense of margins and shortening the economic life span of these assets in the process does not yield the optimal returns we believe are achievable with a little patience and a disciplined approach to pricing and incentives. Therefore, we continue to focus on driving profitability on every home we sell even if the result is a pace that is below our historical average.

This strategy reflects our commitment to maximizing long-term profitability rather than focusing solely on immediate output. Further, it ensures we sustain our strong margins and generate value for shareholders over a longer period, balancing today's performance with tomorrow's opportunities. The success of the strategy played out again during the third quarter as we delivered an adjusted gross margin of 27.2%, up 20 basis points from the prior quarter and in line with our standout results from the same period last year. Additionally, we delivered a pre-tax net income margin of 14.1%, up 130 basis points sequentially and significantly higher than our pre-pandemic average of 12.8%.

These and other achievements contributed to diluted earnings per share of $2.95, representing an increase of 4% year over year and 19% sequentially. During the quarter, we averaged 4.4 closings per community per month. Our top market on a closings per community basis were Las Vegas was 9.9, Nashville with 9, Charlotte with 8.9, Dallas/Fort Worth was 6.4 and Tampa also with 6.4 closings per community per month. Congratulations to these teams in these markets and their outstanding performance last quarter.

One final highlight. We were proud to be recognized by Newsweek for the second consecutive year as one of the world's most trustworthy companies. This award underscores our commitment to integrity and excellence with our customers, with our employees, and with our investors. This recognition highlights the strength of our culture and the integrity of our employees who provide exceptional customer service as they help families across the country achieve the dream of homeownership.

With that, I'll invite Charles to provide additional details on our financial results.

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Thanks, Eric. As mentioned earlier, our revenue in the third quarter increased 5.6% year over year to $651.9 million. During the quarter, we closed 1,757 homes, slightly higher on a year-over-year basis and 6.2% higher sequentially. We closed 160 homes through our wholesale business, representing 9.1% of our total closings, compared to 7.9% last year.

Those closings resulted in revenue of $49.5 million an increase of 14.2% compared to last year. Our average sales price was a record $371,004, an increase of 5.2% over the same period last year and 1.9% sequentially. The increase was primarily driven by our decision to maintain profitability through price increases in the majority of our markets, as well as a larger percentage of closings in markets with higher average price points, particularly our West and Northwest segments, and was partially offset by a slightly higher percentage of wholesale closings. Our gross margin performance again reflected the balanced use of financing incentives and our ability to offset the financial impact of these tools are raising prices and taking a disciplined approach to the absolute level of rate buydowns.

As a result, our third quarter gross margin was 25.1%, and our adjusted gross margin was 27.2%. As Eric mentioned, adjusted gross margin improved 20 basis points sequentially and was in line with the prior-year results in our pre-pandemic average. Adjusted gross margin excluded $13 million of capitalized interest charged to cost of sales and $1.2 million related to purchase accounting, together representing 210 basis points, compared to 150 basis points last year. Combined selling, general, and administrative expenses for the third quarter were $83.2 million or 12.8% of revenue.

Selling expenses were $55.2 million or 8.5% of revenue, compared with 8.1% in the same period last year. The increase was primarily related to higher advertising spend and to a lesser extent, increased personnel costs related to new community openings. General and administrative expenses totaled $28 million or 4.3% of revenue, in line with the same period last year. Based on our performance to date, we now expect our full-year SG&A expense as a percentage of revenue to range between 14% and 14.5%.

Pretax net income was $91.9 million, compared to $89.4 million during the same period last year. Pretax net income as a percentage of revenue was 14.1%, compared to 14.5% last year and 12.8% in the second quarter. Our effective tax rate was 24.3%, compared to 25.1% last year. Given our performance to date, we expect our full-year tax rate will be approximately 24.5%.

Overall, we generated net income of $69.6 million or $2.96 per basic share and $2.95 per diluted share. Gross orders in the third quarter were 1,967 net orders were 1,452 and our cancellation rate was 26.2%, down slightly compared to last year. We ended September with 1,088 homes in our backlog, representing $417.8 million. At September 30, our land portfolio consisted of 68,564 owned and controlled lots.

Of those lots, 54,029 or 78.8% were owned, and 14,535 lots or 21.2% were controlled. Of our own lots, 38,734 were classified as raw land and land under development with less than 30% of those lots in active development. Of the remaining 15,295 owned lots, 10,827 were finished vacant lots. 2,491 were completed homes and information centers.

And during the quarter, we started 1,554 homes and had 1,977 homes in progress at quarter end. With that, I'll turn the call over to Josh for a discussion of our capital position.

Josh Fattor -- Vice President, Investor Relations

Thank you, Charles. We ended the quarter with $1.5 billion of debt outstanding, including $863.3 million drawn on our revolver, resulting in a debt-to-capital ratio of 43.6%, and net debt-to-capital ratio of 42.7%. Total liquidity was $375.4 million, including $60.9 million of cash and $314.5 million available to borrow on our credit facility. Our stockholders' equity at September 30 was $2 billion, and our book value per share was $84.93.

On October 9, we successfully amended our credit agreement, and we're pleased to have several lenders who previously planned to exit in April of next year choose to extend our capital commitments through April 2028. Their decision to extend for the full duration of the facility offsets $125 million of the $245 million reduction in capacity that we previously expected in April. Therefore, under the terms of the new agreement, we will maintain our total capacity of $1.25 billion through April 2025 and have $1.085 billion of capacity through April of 2028. At this point, I'll turn the call back over to Eric.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Thanks, Josh. We're pleased with the strong results we delivered in the third quarter and all of our accomplishments year to date. Turning to the current sales environment. I'll provide our thoughts on the fourth quarter to date and briefly discuss our updated guidance.

Later today, we plan to report that we closed 526 homes in October, down slightly from the prior year. While lease and traffic in October were similar compared to September, we did experience a moderation of sales activity in October, a trend that appears to have been broadly experienced across the industry. Part of this is certainly related to our growth and the time it takes to get new hires trained and selling the LGI way, as well as the impact of higher rates on affordability. We believe this is a near-term dynamic and not a new normal.

The fundamentals of the housing market are strong, supported by continued household formations, years of underproduction and limited supply of resale homes. Finally, the U.S. economy continues to grow and remains productive, resulting in a resilient labor market and historically low unemployment. In short, the long-term outlook is undeniably positive.

Based on recent demand trends, our results to date, and outlook for the next two months, we now expect to close between 6,100 and 6,400 homes this year at an average selling price between $360,000 and $370,000. Margins in the fourth quarter are expected to be similar to slightly lower than what we delivered in the third quarter depending on geographic product and retail versus wholesale mix, as well as the cost of incentives offered during an annual make or move sales event. Based on those variables and our strong performance to date, we are raising our full-year margin guidance by 50 basis points at both the low and the high ends and now expect to deliver gross margins between 24% and 25% and adjusted gross margins between 26% and 27%. As I highlighted at the beginning, community count continues to grow.

Community count held steady at 138 in October, and we have 12 new community openings planned for November. We continue to expect to end 2024 with approximately 150 active communities. Additionally, we expect another 10% to 20% growth in our community count in 2025. In conclusion, I want to thank our employees.

Your hard work, dedication, and execution on our strategy were essential to our success in the third quarter. Thanks to your outstanding efforts, we are well-positioned to continue delivering profitable results and creating long-term value for our shareholders. We'll now open the call for questions.

Questions & Answers:

Operator

Certainly. [Operator instructions] One moment for our first question, which will come from Trevor Allinson of Wolfe Research. Your line is open, Trevor.

Trevor Allinson -- Wolfe Research -- Analyst

Hey, good afternoon. Thank you for taking my questions. First one on gross margin performance, which was really impressive in the quarter. You raised your full-year gross margin expectation in what most builders are describing as a challenging incentive environment.

Can you talk about what came in better than what you were anticipating and sort of bridge us from your prior guide to your updated guide?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah, Trevor. This is Eric. I can start. It's really just what we're seeing as far as updating the guidance with our results from Q3 and then anticipating what it's going to be and the overall yearly guidance needs to be upgraded.

And I think it goes back to that pace versus price initiative and probably some questions on that. And like other builders, we have to put a margin on top of our costs. And we are looking at incentives closely. We're looking at the value of our land underneath every house we build and certainly houses that are complete, we need to incentivize but we've been avoiding wholesale price reductions because in most cases, just reducing the prices doesn't necessarily increase your pace.

There's other things we'd look at like marketing, product, training. We have a lot of new hires right now, but we're weighing all of those incentives.

Trevor Allinson -- Wolfe Research -- Analyst

OK. Got you. Makes sense. And then, Eric, I wanted to follow up on a comment you made in your prepared remarks.

I think talking about kind of near-term dynamics, not necessarily being a change for the industry. You've heard a lot of builders talk about nonrate impact to demand conditions. A lot of people cite the election. So is it your view here is that we get past the election into early next year that even if rates remain elevated, that you could still see some improvement in demand to the spring selling season? Or do you think that's truly going to be dictated by rates and affordability? And then maybe perhaps your view is that where rates are currently isn't going to be sustained as we move through 2025.

Thanks.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. I think, Trevor, for us, it's a -- we look at demand as the number of leads that we have coming in. So the demand for homeownership and what we're seeing in the field is -- remains strong. Over 8,000 individual leads last week inquired by homeownership, so we don't believe the election has anything to do with demand.

The challenge with our pace right now and what we're working through every day in the offices nationwide is entry-level affordability. Affordability is challenged right now, the combination of rates being higher and the average price. As we stated in our prepared remarks, average sales price this quarter was the highest in company history. Those two are leading to affordability challenges and the amount of income it takes to qualify for an entry-level house.

We have eliminated -- the market has eliminated the customer that makes $60,000 to $100,000 a year in combined income has been eliminated from the market, just from a qualification standpoint relative to their income to what the ratios are. So that's the challenge we have on a pace standpoint, but that is about the only component that is cautious right now is the absorption pace because gross margins are strong. Demand is strong. Community count growth is strong, a lot of positive things happening in our business.

Trevor Allinson -- Wolfe Research -- Analyst

Appreciate all the color. Thank you, and good luck moving forward.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Thanks, Trevor.

Operator

And one moment for our next question. Our next question will go to Andrew at J.P. Morgan. Andrew, your line is open.

Andrew Azzi -- JPMorgan Chase and Company -- Analyst

Hi, everyone. This is Andrew Azzi on for Mike. Congrats on the quarter. Just to go again on the gross margins.

In your view, what's allowing you to maintain this level of margin and hold it relatively steady as compared to your peers? And how should we think about the next two to three quarters as you adjust prices of new communities of their openings?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah, Andrew. I'll answer it another way as well from a -- believe it on how we price our homes, but also we tend to do a lot of land development at LGI, a lot of sales development. And also, our gross margin from a company standpoint, we have to capture both the development profit and the homebuilding profit. So our gross margin should be higher than our peers because we need to capture that development crop.

But the other item we talk about internally is there is a lot of value in the land that we develop, and we're financing that more on balance sheet than off-balance sheet. Relative to our peer group who has really went all in on land banking, land banking is expensive. There is a lot of value to land banking as it relates to certain metrics like return on equity, but it is a headwind to gross margin. We have a cost advantage as it relates to gross margin and our lot cost because we are keeping everything on balance sheet than doing a lot of land banking, I think that's also an important point.

Andrew Azzi -- JPMorgan Chase and Company -- Analyst

Got it. I appreciate that. And then kind of in terms of land inflation, what are you kind of seeing in terms of land contracted today? And maybe if you can help us understand the difference between development versus the actual land purchases? Any color there would be helpful.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah, Trevor. Obviously, it's -- or excuse me, Andrew. Obviously, it's different in every market. Generally speaking, land prices are not coming down, still strong demand for land.

The bigger component for us is that a larger percentage of the finished lot is the development costs. Development costs remain elevated. Don't see a lot of relief in development costs either, doing business with the cities and counties and planting fees. We just believe costs are going to continue to go up for our development.

We are starting to see because of challenges for the private builders. We are starting to see more opportunities to buy finished lots on a takedown or by an opportunity where capital wasn't available for a builder, not necessarily a distressed pricing levels, but it may create more opportunities to grow our community count in the future as well.

Andrew Azzi -- JPMorgan Chase and Company -- Analyst

Got it. Thank you so much for taking my questions.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Thanks, Andrew.

Operator

And one moment for our next question. Our next question will be coming from Carl Reichardt of BTIG. Your line is open, Carl?

Carl Reichardt -- Analyst

Thanks. Hey, guys. Nice to talk to you. Just one housekeeping question for you, Charles.

Just the other income this quarter, at least relative to our number was basically all the difference between our EPS estimate and what you produced. What was that this quarter? And then do you have a sense of the run rate going forward in the fourth quarter and then even into next year on what that might be?

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Yeah, Carl. This quarter, we had about $4.5 million related to land sales compared to last quarter, it was at 2.7%. So the majority of the delta this quarter over the last was related to some additional lot sales. We expect it to be lumpy going into the fourth quarter and into the future.

So I don't really have specific guidance for you in terms of what we think fourth quarter or 2025 will be.

Carl Reichardt -- Analyst

OK. Thanks. I thought that might be it. And then for you, Eric, just -- I think I may have asked this before, so I want to touch on it again.

So if I look at your absorption rates per community you're down about 33% from where you were in '22, your ASP is up about 5% from there. If I look at your -- the midpoint of your year-end guide. So how are you changing compensation structure for sales to focus more on margin if absorptions, I assume per salesperson are falling? How do you sort of true them back up to get them to focus on that dynamic as opposed to turnover?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. It's a great question, Carl. I think the focus is really leaving that commission percentage the same. We believe we pay one of the highest commission rates to our salespeople in the industry.

We know we do and having that same percentage on a higher ASP, even though the unit volume may be down in a per community, the overall revenue that an individual salesperson creates or a community creates is very similar to it was a few years ago. So the income is not as effective as much because they're paid on the revenue part of it.

Carl Reichardt -- Analyst

OK, great. Thanks, Eric. Appreciate it, guys.

Eric Thomas Lipar -- Chair and Chief Executive Officer

You're welcome.

Operator

One moment for our next question. And our next question will come from Jay McCanless of Wedbush. Your line is open, Jay.

Jay McCanless -- Analyst

Hey, guys. So a couple of questions. The first one, Eric, that comment you made about households with a $60,000 to $100,000 income priced out of the market now. I mean, how many households, how many potential customers do you think you're talking about there that now can't look at homeownership?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. I don't have that answer off the top of my head, Jay. But I think it's a pretty significant number. I was in the sales office this last weekend and work and get into the field as much as I can, and there's just a lot of customers in that range that are right now forced to keep running or they have to save more money for down payment or have to pay more down debt.

So our team does an exceptional job of working with these customers and helping them get in the position where they can buy. But household income because of rates in ASP, that measure, as we all know, is just more constrained than it used to be that difference between owning a home and paying for rent. That gap is wider now than it has been in the past. Also, a lot of our customers over the years have used various bond programs that are put out by various states and local community agencies across the United States.

And with those local bond programs, you don't have the ability to do a forward commitment and buy down rates. So a lot of those programs today have a market rate of 7%, 7.5%, which is a completely different rate than what it was three or four years ago.

Jay McCanless -- Analyst

And I guess not -- I know you aren't ready to give '25 guidance yet, but kind of to what Carl was asking about in terms of pace. I mean, what are you guys thinking about is going to be the right pace because closings have missed your mark the last couple of years, and just wondering how you all are thinking about it, especially if rates don't go down from here? Should we be expecting a pace in line with what we saw back half of '24? Or just how are you guys thinking about it, especially with all the communities that you're going to be bringing out of the ground?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. It's a good question, Jay. We're looking at pace. We're also looking at revenue community, ASP, gross margins, etc.

We're not going to give '25 guidance today. But from the seat we sit in, I think, '25, especially since it's -- we're selling for '25 right now, '25 is basically here. No reason to think the '25 pace is any different than the '24 base. But also, we would think that would result in a very positive year for LGI next year.

ASP, no reason that doesn't continue to go higher, we just talked about on the call an additional 10% to 20% in community count growth next year, strong gross margin, staying in our elevated range, increasing EPS, a lot of new growth with our employees. One of the things I will point to, Jay, is it has been proven time and time again at LGI is sales representatives, LGI management, LGI employees in their second year of the business do a lot better than the first year of the business. And we have had such strong community outgrowth, and we've got so many new employees, new sales reps, new managers that I'm excited about all of those individuals getting into their second year in the business in 2025, and that will have a positive impact on the company.

Jay McCanless -- Analyst

So then, I guess, the other question, just to take all that, Eric. To stick on affordability for a second. I mean, do you feel like your plans -- and I know you guys have a pretty tight plan book. Do you feel like there's more opportunities to bring down the size of the plans? Or if you kind of hit that terminal bottom where, at some point, it's just not a house anymore.

It's more of an ADU than it is a house, right?

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. No, I think we're about there, Jay, because we've been looking at affordability and our plans for quite a while now. Certainly, on new communities, we're always looking at that. We want to build a quality affordable house.

We're going to look at square footage as the primary driver to reduce the overall affordability and make it as affordable as it possibly can. So I also don't think we're going to chase square footage down to the absolute bottom. Some of our competitors are building product with no garages, one car garage. There's just a product that's here at LGI, we would not be comfortable building with.

We won't be proud of the product that we're building. We're going to be consistent with our fit and finish nationwide all of our houses nationwide have hard surface countertops. There is certainly, in addition to the product exterior, there are certainly components that we could take out more of the fit and finish inside and probably take a couple of thousand hours out of the house, but we're not sure the value is really there, and we want to be proud of the product that we're building and make sure it's a great product for our customers to move into.

Jay McCanless -- Analyst

Understood. And just one more question. I don't know how much people talk about it, but you guys do have Terrata. Move-up price points seem to be selling really well at this point.

I mean, is a thought process that until rates come down, our affordability gets better, maybe you convert some of this over to Terrata and ride some of this wave that we're seeing in the move-up and, call it, entry-level luxury markets.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah. I mean, certainly, depending on the market, depending on the community, since we do a lot of development, we got many larger communities In fact, I was in a meeting this morning. We're going to have Terrata and LGI Home product in the same actual community. So Terrata's going well for us.

We believe it's going to be continued growth in the future. Ever since, I believe it was 2017 when we had our first Terrata closing, Terrata closings have increased every year and looking forward to doing more Terrata product in the future. And we'll look at that on a community-by-community basis, Jay, but good comment.

Jay McCanless -- Analyst

Great. Thanks. Appreciate it.

Eric Thomas Lipar -- Chair and Chief Executive Officer

You're welcome.

Operator

One moment for our next question. Our next question will be coming from Alex Barron of Housing Research Center. Your line is open, Alex.

Alex Barron -- Housing Research Center -- Analyst

Thank you. Hey, guys. I wanted to ask also along the lines of Dave's questions. I think most of your homes are usually single family.

I don't recall you guys doing too much attach product, but is that anything you guys are considering are looking at as a way to make houses more affordable?

Eric Thomas Lipar -- Chair and Chief Executive Officer

We are, Alex, and we do have a number of attach home products across the United States, and we certainly look at that. We'll continue to look at that. And part of our community count growth next year will be attached product as well.

Alex Barron -- Housing Research Center -- Analyst

Got it. And then my other question was, I think I heard you say the SG&A ratio is in the 14% range. Many of the larger public builders are now below 10%, whereas in previous years, never used to go below 10%. So is there anything you guys are working on to try to bring down the SG&A ratio?

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Yeah. Nothing specific, Alex. This is Charles. I mean, I think we're comfortable in our advertising spend, and we're -- we break it down into two categories.

So you have selling expenses, which is predominantly advertising spend commissions to both inside and outside salespeople and then running our offices. So as community count continues to grow. We continue to invest in new community openings, information centers across the country. From a G&A standpoint, then that's more of our corporate overhead and support operation, we've been running around an average of about $30 million a quarter.

This year, the third quarter came in a little bit under than our average. So we continue to monitor expenses from an overhead standpoint to make sure that we are supporting the field in the best way possible. And really, right now, we're focused more on community count growth and getting these new communities opening in the markets, not a lot of geographic expansion in terms of where the new communities are coming from. They're coming from our existing markets.

So we hope to leverage off of having the established overhead in those markets going into the future.

Alex Barron -- Housing Research Center -- Analyst

OK. And if I could ask one last one. Any thoughts around issuing fixed -- more fixed-rate debt to swap out the lines of credit?

Eric Thomas Lipar -- Chair and Chief Executive Officer

It's something that's always on the radar for us, Alex. We evaluate those opportunities. We're constantly informed by our syndicate where rates are and where our current bonds are trading. So we want to make sure it's an attractive situation and there's actually a good use for the capital, but it is something that we're constantly looking at.

Alex Barron -- Housing Research Center -- Analyst

Got it. Best of luck, guys. Thank you.

Eric Thomas Lipar -- Chair and Chief Executive Officer

All right. Thanks, Alex.

Operator

One moment for our next question. And our next question will come from Kenneth Zener of Seaport. Your line is open.

Kenneth Zener -- Analyst

Afternoon, everybody. A few questions here for you. I understand that you don't want to give FY '25 pace gross margin. Maybe you could illuminate in terms of your either returns on capital or equity goals, so we could understand how you are balancing that margin, which is clearly against peers trends right now, just in terms of the asset efficiency side, as you outlined your return goals.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Yeah, Ken. This is Eric. I can start, and then Charles can add specific. So I think for next year, without getting into specific guidance, which will get very similar pain and similar gross margins to this year because we believe we're at a historical average, and we'll always be there.

Obviously, it depends on wholesale versus retail mix and geographic mix and incentives, there's variables there. And then when we're buying a deal, we're underwriting to a 20% ROE. But what has happened over the last couple of years, we've got a lot of investment in land all these communities that we are bringing online the 30% year over year and the additional 10% to 20% growth. That has all just been expensed right now.

We are not seeing any revenue for those communities. So we believe our ROE is going to be increasing over the next couple of years and heading in a positive direction.

Kenneth Zener -- Analyst

Appreciate that. Very good. As we think about your land, which has been in development on the balance sheet and capitalized interest, it's been picking up. Is it reasonable to assume the current, I know you gave fourth quarter guidance in terms of the gross margin, interest expense spread.

But is that going to be increasing next year as these longer-dated land physicians come on or through the income statement?

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Yes, Ken, this is Charles. I mean, I think we've been running around 180 and up to 200 basis points as far as what we can see in terms of visibility right now, I would say we're going to be somewhere in and around that 200-basis-point range as we go into 2025, but we'll certainly give more color on that as we get closer into giving guidance for next year.

Kenneth Zener -- Analyst

Excellent. And then my one last question. Because your development is so specific and I think it's obviously been helping you guys consistent with your past, is there a way you could comment on the cost of your land cost as a percent of sales versus your variable costs, which I assume both on the development of land are more similar to other builders considering the common trade that you use? Thank you very much.

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Yeah, I can start. I think our average finished lot cost as a percentage of our ASP has been pretty close to around 20%, just under for quite some time. I think that's part of the way, as Eric was explaining how we think about pricing and achieving a return is that we would expect that to remain relatively consistent when you're buying finished lots, that number can push up. But from a development standpoint that usually stays in somewhere around that number, the actual raw land portion is somewhere around 10% of the total finished lot cost.

So most of the variability we see when we look at development costs and what it costs to replace the project are going to be included in the infrastructure requirements. Are there off sites required? What are the municipalities requiring us to do in order to bring that deal online? How much yield can we get out of the project due to detention requirements and those things? So the vast majority of the replacement costs come in the development spend.

Kenneth Zener -- Analyst

Thank you very much.

Operator

At this time, I'm not showing any further questions. I'd like to hand the call back to Eric for closing remarks.

Eric Thomas Lipar -- Chair and Chief Executive Officer

Thanks, everyone, for participating on today's call and your continued interest in LGI Homes. Have a great rest of the day.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Josh Fattor -- Vice President, Investor Relations

Eric Thomas Lipar -- Chair and Chief Executive Officer

Charles Michael Merdian -- Chief Financial Officer and Treasurer

Eric Lipar -- Chair and Chief Executive Officer

Trevor Allinson -- Wolfe Research -- Analyst

Andrew Azzi -- JPMorgan Chase and Company -- Analyst

Carl Reichardt -- Analyst

Charles Merdian -- Chief Financial Officer and Treasurer

Jay McCanless -- Analyst

Alex Barron -- Housing Research Center -- Analyst

Kenneth Zener -- Analyst

Ken Zener -- Analyst

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