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Updated from 7:38 a.m. EDT

Is the luxury home market humming along with little regard for rising interest rates, as

Toll Brothers


depicts it, or are wealthy buyers making last-minute purchases before mortgages get too expensive?

That's the question facing investors following Wednesday's third-quarter update from Huntingdon Valley, Pa.-based Toll. And for several reasons, including the durability of the luxury niche and the cushion embedded in adjustable rate mortgages, Toll is still in good shape.

The company said Wednesday that homebuilding revenue was $679 million in the quarter, up 20% from the year-ago quarter, while new contracts came to $953 million on 1,671 homes, up 35% from last year. Both metrics represented record highs for the company and the shares rallied on the news.

"Since June 16, when interest rates began to rise, we have seen no decline in demand -- in fact, it has accelerated," said Toll Brothers' Chief Executive Robert I. Toll in a written statement. "While rising rates may have pushed some 'fence-sitting' buyers to jump in before rates rose further, we attribute most of the continuing strength in demand for our homes to increasing numbers of affluent households and our ability to control home sites, gain approvals and open communities in the lot-constrained markets where buyers of luxury homes most want to live."

Toll forecast "record results" for 2004, citing current contract levels. The company said on a conference call that it expects to sell about 6,000 total homes and generate revenue of $3.1 billion in 2004, and predicted 15% annual growth for the next several years. The company didn't provide an earnings prediction.

Analysts surveyed by Thomson First Call expect it to earn 79 cents a share in the third quarter, $3.25 a share in full-year 2003 and $3.60 a share for all of next year on 2004 revenue of $3.09 billion. Third-quarter results will be released Aug. 26.

"The market is getting more expensive and is demanding a changing product," Chief Executive Toll said. "There are a lot more wealthy buyers coming into the market."

How do the company's results compare with other players in the housing market?

"We do not believe Toll's results, as the niche luxury builder, are indicative of the industry," wrote J.P. Morgan analyst Michael Rehaut in a Wednesday research note. He believes the company's increase in order growth might have been helped by "pent-up demand" from a weaker second quarter and new community openings in California.

Additionally, because Toll targets the niche luxury market, Rehaut noted that its customers are less prone to interest rate increases. Rival



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saw July orders increase 12%, a deceleration from its 16% quarterly growth rate, according to Rehaut, who has a neutral rating on the company. (J.P. Morgan has not had an investment banking relationship with Toll within the last 12 months.)

On Tuesday, Hovnanian reported that third-quarter net contracts rose 48% to $964 million. Contract backlog was up 33% to $1.6 billion, or 5,718 homes.


D.R. Horton


recently reported a better-than-expected third quarter, with profit up 48%. And



had a 61% rise in first-quarter earnings.

Toll was up $1.94, or 7.33%, at $28.41. Hovnanian rose 5.97%, or $2.89, at $51.29 recently.

Overall, despite a

selloff about a month ago, housing stocks remain strong. Most are down from mid-June, directly after the rate increase, but still much higher year to date. Toll, for example, is down 10.8% from June 17, but up 21.3% year-to-date, while Hovnanian is down 25% since June 17, but up 42.9% year to date.

Toll said that, historically, it has grown during times of rising mortgage rates, in such years as 1995, 1997 and 2000. But, according to Larry Horan, director of research at the investment banking firm Parker/Hunter, that's not big news. "That is true for most of the publicly traded homebuilders that I've followed since 1995," said Horan, who holds shares of Toll as well as several other homebuilder stocks.

The average contract interest rate for 30-year fixed-rate mortgages rose to 6.37% from 5.87% a week ago, the Mortgage Bankers Association said Wednesday. But when a rate reversal such as this occurs, buyers don't stop buying, Horan said. Instead, "people tend to move down the yield curve and more adjustable rate mortgages are issued." ARMs have a maximum interest rate that can change annually and usually start with a better rate than a fixed-rate mortgage.

"The last time we had a major run up in Treasuries, which amounted to about a 250 basis point run-up, the average effective mortgage rate went up about 45 basis points," said Horan. As such, the adjustable-rate mortgage share of activity increased to 21.7% this week from 20.6% the previous week, the MBA also reported Wednesday.

"Interest rates are still quite a bargain," said Toll on the call."When you get a lousy housing market, you would get incentives or mortgage buy downs, but I think we're far from that."