Executive Summary / Key Takeaways

• The D.R. Horton (DHI) Relationship Defines the Investment Case: Forestar's 62% ownership by America's largest homebuilder creates a unique moat through preferred access to land deals and a contracted backlog representing $2.1 billion in future revenue, but this concentration also introduces existential risk if the relationship deteriorates or if DHI's growth slows materially.

• Capital Efficiency as a Weapon in a Starved Industry: With $968 million in liquidity and a net debt-to-capital ratio of just 19.3%, Forestar is consolidating market share in a highly fragmented lot development industry where most competitors lack access to project-level financing, positioning the company to double its market share to 5% over the intermediate term.

• Affordability Headwinds Are Biting, But Execution Remains Solid: Despite 10% revenue growth to $1.66 billion in FY2025 and an 11% increase in book value per share, pretax margins compressed to 13.2% as homebuilders offered increased incentives to offset elevated mortgage rates, demonstrating the company's resilience but also its sensitivity to interest rate dynamics.

• Guidance Reflects Cautious Optimism Amid Macro Uncertainty: Management's FY2026 outlook for 14,000-15,000 lot deliveries and $1.6-1.7 billion in revenue suggests flat to modest growth, with the first quarter expected to be the weakest, reflecting continued affordability constraints but also a disciplined approach to capital deployment ($1.4 billion planned investment versus $1.9 billion in FY2025).

• Two Variables Will Determine Success: The investment thesis hinges on whether Forestar can maintain its underwriting discipline (15% pretax return, 36-month cash return) while scaling operations, and whether the D.R. Horton relationship can grow from 15% of DHI's starts toward the mutually stated goal of 33% without triggering further conflicts of interest or litigation.

Setting the Scene: A Pure-Play Lot Developer in a Builder's World

Forestar Group's corporate lineage traces to 1954, but the modern company emerged in 2007 when Temple-Inland spun off its real estate operations as an independent public entity. The transformative event occurred in October 2017 when D.R. Horton acquired 75% of Forestar's common stock, creating a majority-owned subsidiary structure that remains unique among public lot developers. As of September 30, 2025, DHI owned 62% of Forestar, a relationship governed by a Stockholders Agreement, Master Supply Agreement, and Shared Services Agreement that grants DHI a right of first offer on up to 100% of lots from DHI-sourced projects and 50% from Forestar-sourced projects.

This structure defines how Forestar makes money. The company operates as a national, well-capitalized residential lot developer, investing in land acquisition and development to sell finished single-family lots to homebuilders across 64 markets in 23 states. Its strategy focuses on entitled short-duration projects developed in phases to match market demand, targeting entry-level, first-time move-up, and active adult homes—the largest segments of the new home market. The company also engages in short-term lot banking and land banking, primarily to D.R. Horton, utilizing available capital before deploying it into longer-term development projects.

The industry context matters deeply. Lot development is highly fragmented, with no meaningful national concentration. Most competitors are local, privately-owned companies reliant on project-level development loans that have become less available and more expensive in recent years. This creates a structural advantage for Forestar, whose balance sheet provides operational flexibility while rivals face financing constraints. The company estimates its current market share at approximately 2.5% and has explicitly stated a goal to double this to 5% over the intermediate term.

However, the industry faces severe cyclical headwinds. The Federal Reserve's interest rate hikes in 2022 and 2023 pushed mortgage rates to elevated levels, reducing home affordability and forcing builders to increase incentives like mortgage rate buydowns to stimulate demand. Forestar's customers—primarily homebuilders—have responded by adjusting their pace of lot purchases, creating choppy demand patterns that the company describes as "returning to more of a pre-COVID take down on a quarterly basis" rather than large bulk purchases.

Strategic Differentiation: The Moats That Matter

Forestar possesses three distinct competitive advantages that competitors cannot easily replicate.

First, the D.R. Horton relationship provides unmatched access and visibility. In fiscal 2025, 15% of DHI's home starts were on Forestar-developed lots, and this reached 23% of DHI's finished lot purchases in Q3 2025. Approximately 22,800 of Forestar's 23,800 owned lots under contract are committed to DHI, representing $2.1 billion in future revenue secured by $193 million in earnest money deposits. This contracted backlog provides revenue visibility rare in the cyclical land development business. The mutually stated goal of one-in-three DHI homes being built on Forestar lots implies a significant opportunity to grow market share within Forestar's largest customer while maintaining relationships with over 20 other builders, including six new customers added in FY2025.

Second, balance sheet strength creates a compounding advantage. Forestar ended FY2025 with $968 million in liquidity and a net debt-to-capital ratio of 19.3%, well below its long-term target of 40%. This allowed the company to refinance $400 million of 3.85% senior notes due 2026 with $500 million of 6.50% notes due 2033 in March 2025, extending maturity while maintaining financial flexibility. Competitors like Green Brick Partners and Howard Hughes Holdings maintain higher leverage or more complex capital structures that limit their ability to invest counter-cyclically. Forestar's low overhead model—SG&A at 9.3% of revenue—further enhances capital efficiency.

Third, disciplined underwriting ensures survival and selective growth. Forestar targets a minimum 15% pretax return on average inventory and return of initial cash investment within 36 months. This discipline shows in the numbers: FY2025 pretax margin of 13.2% and full-year gross margin of 21.87% demonstrate that the company can generate acceptable returns even while absorbing cost pressures from inflation and supply chain disruptions. The company mitigates real estate inventory risks by limiting project size, developing for known buyers, and diversifying geographically, with 37% of owned lots already under contract and another 27% subject to DHI's right of first offer.

These advantages translate into operational metrics that outpace fragmented competitors. Forestar sold 14,240 lots in FY2025 at an average price of $108,400, with a lot position of 99,800 lots (65% owned, 35% controlled). This scale enables the company to negotiate favorable terms with contractors and materials suppliers, while smaller developers face cost pressures and delays.

Financial Performance: Resilience Amid Margin Pressure

Forestar's FY2025 results demonstrate both the strength and vulnerability of its model. Revenue increased 10% to $1.66 billion, driven primarily by a higher average selling price per lot due to regional mix shifts, partially offset by a 5% decrease in lot sales volume. This pricing power reflects the national shortage of finished lots but also masks underlying demand softness.

Pretax income of $219.6 million yielded a 13.2% margin, down from prior year levels as SG&A expense as a percentage of revenue rose to 9.3% from 7.9% in FY2024. The average employee count increased 24% to 433, with 90% of new hires in local market operations to support community count growth. This investment in personnel, while pressuring near-term margins, positions the company to execute its consolidation strategy.

Quarterly trends reveal the impact of market conditions. Q4 2025 gross margin of 22.3% decreased 160 basis points year-over-year, though the prior year benefited from an unusually high-margin project. Q3 2025 gross margin of 20.4% was similarly impacted by the closeout of a low-margin community. These fluctuations demonstrate the project-level volatility inherent in lot development, even for a scaled operator.

Cash flow performance highlights the capital intensity of the business. FY2025 operating cash flow was negative $197.7 million due to $1.7 billion invested in land acquisition and development, with approximately two-thirds allocated to development and one-third to acquisition. However, quarterly operating cash flow turned positive $256.3 million in Q4 as the company moderated investment pace, showing management's ability to adjust to market conditions. Free cash flow was similarly negative $197.7 million for the year but positive $255.6 million in Q4.

The balance sheet remains a source of strength. Total debt of $873 million at year-end represents a debt-to-capital ratio of 31.2%, with no senior note maturities until 2029 following the refinancing. The company increased its revolving credit facility to $665 million in October 2025, providing additional liquidity for opportunistic land purchases. S&P's upgrade to BB- in January 2025 reflects this financial stability.

Outlook and Execution: Moderating Growth, Maintaining Discipline

Management's FY2026 guidance signals a more cautious investment posture while maintaining growth ambitions. The company expects to deliver 14,000-15,000 lots and generate $1.6-1.7 billion in revenue, implying flat to modest growth versus FY2025. The first quarter is expected to be the lowest delivery period, with revenues weighted toward the second half—a pattern consistent with FY2025's seasonality.

Planned investment of $1.4 billion in land acquisition and development represents a 26% reduction from FY2025's $1.9 billion, reflecting management's response to affordability constraints and cautious consumer sentiment. This capital discipline is prudent given the macro uncertainty but may slow market share gains if competitors become more aggressive.

The company expects headcount to remain flat or decline slightly in FY2026, which should improve SG&A leverage as revenue grows. This operational leverage is critical to expanding margins from current levels. Management's commentary suggests land development costs have stabilized and contractor availability remains solid, though governmental delays continue to extend cycle times above historical norms.

The path to doubling market share to 5% requires Forestar to grow at a mid-single-digit pace while DHI expands at a low-single-digit rate, reflecting DHI's larger size and expansion into new markets where Forestar may not have presence. This dynamic creates a natural governor on growth but also ensures the relationship remains mutually beneficial.

Risks and Asymmetries: Where the Thesis Can Break

The most material risk is customer concentration. With 62% ownership and a right of first offer on 27% of owned lots, DHI's strategic decisions directly impact Forestar's results. If DHI's growth slows, shifts to self-development, or renegotiates terms, Forestar's revenue and margins could compress materially. The derivative complaint filed in April 2025 alleging breach of fiduciary duty related to lot sale transactions highlights the inherent conflict in the relationship, though management maintains the transactions are at market terms.

Interest rate sensitivity presents a macro risk. Prolonged high mortgage rates could further depress homebuilder demand, forcing Forestar to reduce lot prices or offer incentives that compress margins. While the company has successfully raised prices where market conditions permit, affordability constraints ultimately limit pricing power.

Geographic concentration amplifies regional risks. Management noted "some pressure in some markets in Texas" and "a little bit more pressure in Florida, parts of Florida," though absorptions remain strong at affordable price points. Natural disasters, regulatory changes, or local economic downturns in these key markets could disproportionately impact results.

Execution risk looms as the company scales. Maintaining 15% pretax return targets while growing community count and entering new markets requires disciplined project selection and operational excellence. The 24% increase in headcount in FY2025 suggests significant organizational investment, but integration challenges could pressure margins if growth slows.

Regulatory delays remain a persistent operational challenge. While cycle times have improved, governmental approval processes continue to extend development timelines, increasing carrying costs and reducing returns. The Maryland stormwater lawsuit filed in September 2024 exemplifies how environmental compliance issues can create unexpected costs and delays.

Valuation Context: Reasonable Multiple for a Unique Asset

At $25.38 per share, Forestar trades at a market capitalization of $1.29 billion, representing 0.78 times trailing sales and 7.71 times trailing earnings. The enterprise value of $1.73 billion yields an EV/EBITDA multiple of 8.13, which appears reasonable relative to the company's growth prospects and balance sheet strength.

Comparing Forestar to ostensible peers reveals its unique positioning. Green Brick Partners (GRBK) trades at 1.33 times sales and 8.46 times earnings, but its integrated homebuilding operations generate higher gross margins (31.84% versus Forestar's 21.87%) while exposing it to more cyclical end-market demand. Howard Hughes Holdings (HHH) commands a premium valuation at 2.74 times sales and 15.64 times earnings, reflecting its master-planned community assets and diversified revenue streams, but its mixed-use focus results in slower lot turnover.

Forestar's price-to-book ratio of 0.73 compares favorably to GRBK's 1.60 and HHH's 1.32, suggesting the market may be undervaluing its asset base. The company's return on equity of 9.98% trails GRBK's 21.45% but exceeds HHH's 8.61%, reflecting its focused lot development model versus peers' more complex operations.

The negative trailing free cash flow of $197.7 million is concerning but reflects intentional investment in land acquisition during a period of market share expansion. Quarterly free cash flow turned positive $255.6 million in Q4 2025, demonstrating the company's ability to generate cash when investment pace moderates. With $968 million in liquidity and no near-term debt maturities, Forestar has ample runway to execute its strategy without external financing.

Conclusion: A Compelling Story Hinging on Execution and Relationship Stability

Forestar Group has carved out a unique position as the only pure-play, national lot developer with a strategic anchor tenant in D.R. Horton. This relationship provides contracted revenue, operational leverage, and a competitive moat that fragmented, undercapitalized rivals cannot match. The company's balance sheet strength and disciplined underwriting create a virtuous cycle: financial flexibility enables selective land acquisition, which drives market share gains and reinforces the DHI relationship.

The investment thesis faces two critical tests. First, Forestar must maintain its return thresholds while scaling operations and navigating affordability headwinds that pressure builder demand. Second, the D.R. Horton relationship must evolve without triggering value-destructive conflicts or renegotiations that erode pricing power.

Valuation appears reasonable for a company with Forestar's market position and growth prospects, but the stock will likely remain range-bound until investors gain confidence in management's ability to execute the consolidation strategy while preserving margins. The key variables to monitor are DHI's lot purchase patterns, Forestar's success in diversifying its builder base beyond DHI, and the company's ability to convert its $2.1 billion contracted backlog into cash flow while maintaining its 15% return target. If Forestar can thread this needle, the path to 5% market share and commensurate valuation re-rating becomes clear.