Lennar (LEN)

TOP CONTRIBUTORS

Chris McFarland

Thomas Shyr

Lennar (NYSE: LEN) is the second largest homebuilder in the United States. In 2009, Lennar delivered 11,478 new homes.^[1] Lennar is heavily exposed to fluctuations in the housing and credit markets. Due to this exposure, Lennar has been hit particularly hard by the rapid decline of prices in the U.S. housing market and the subsequent subprime lending crisis in 2007 and early 2008.

Like most homebuilders, it finances most of its operations through large lines of credit with major financial institutions. The volatility in the housing market has made assessing risk very difficult and consequently, financial institutions are unwilling to lend as freely. However, Lennar has set itself apart from other homebuilders by selling assets, paying off debts, and increasing its cash reserves, all of which help protect its long-term outlook from short-term drops in demand for residential housing.^[2]

Company Overview

The core of Lennar's business model is the mass-production and sale of single-family attached and detached homes. Lennar buys the land, outsources the construction, and then markets and helps finance the sale of its homes.

In order to differentiate their homes from those of other vendors, Lennar employs a wide variety of marketing techniques. First and foremost, they include many luxury items as standard features in all of their homes.

Also, by streamlining the land acquisition, construction, selling, and financing process, they are able to lower costs and offer homes at lower prices in more competitive regions. Furthermore, they also have a wide range of prices in their housing portfolio. This allows them to target a large group of customers.

Lennar also offers mortgage financing services. Traditionally, they have helped secure regular, jumbo, and subprime loans for their customers. Due to the recent credit crisis, however, mortgage interest rates have risen dramatically, the market for subprime loans is virtually nonexistent, and larger down-payments for homes are required. These effects have greatly reduced the number of customers who are financially able to buy a home.

Business Financials

In 2009, LEN earned a total of $3.12 billion in total revenues. This was a substantial decline from its 2008 total revenues of $4.58 billion. However, despite the decrease in total revenues, LEN was able to improve its net income. Between 2008 and 2009, LEN was able to reduce its net loss from a loss of $1.1 billion in 2008 to a net loss of $417 million in 2009.^[3]

Trends and Forces

Regulations on the secondary mortgage market increase Lennar's risk

Lennar sells most of the loans it originates in the form of mortgage-backed securities. Regulations on the secondary mortgage market, as well as the decline in demand for mortgage-backed securities could force Lennar to pay its borrowers from its own reserves. This will lower its cash reserves and increase its exposure to defaulting risk.^[4] In particular, the Mortgage Reform and Anti-Predatory Lending Act would make loan originators, and to a certain extent, companies creating mortgage securities, liable if loans are made to unqualified people.^[5]

Real estate prices must stabilize before Lennar can continue large-scale operations

Since Lennar buys the property on which it builds, unstable prices may force it to sell its houses at a loss. Lennar has already been forced to do this once before due to weakeness in the housing market. The real estate market will have to stabilize before Lennar commits to purchasing large tracts of land for residential development^[6].

Overproduction by the housing industry may hurt Lennar's sales

During the housing boom, many homebuilders began overproducing homes. Now that the housing market is in decline, many of these companies are selling houses at significant discounts or even at a loss. If Lennar does not want to sell its houses at a loss, it may be forced to keep the debt associated with it in its balance sheet, which in turn will affect its ability to borrow money.

Lennar's operations are highly susceptible to natural disasters

Two of Lennar's most important states (Florida and California) are exposed to natural disasters. Such an event would damage Lennar's properties and construction material, resulting in a smaller inventory turnover ratio. Furthermore, its insurance policy may not cover all damages caused by natural disasters.

Competition

Lennar faces competition from other homebuilders as well as from the used housing market. The market share of the top three firms is about 12%, with Lennar at 4.31%^[7]. This helps illustrate the magnitude and importance of the used housing market.

Homebuilders

Lennar competes against other national homebuilders, as well as homebuilders in the regional and local levels. In some locations, this may force Lennar to lower the profit margin on its homes.

D.R. Horton (DHI) is the largest homebuilder in the United States based on homes closed. They operate in all of the same regions and offer the same services as Lennar.

Pulte Homes (PHM) is the third largest homebuilder in the United States. Although they offer the same services as Lennar, they sell more expensive and exclusive homes, which limits its threat to Lennar in lower-income markets.

Used housing market

Lennar also faces competition from the used housing market. Customers may decide on buying a house from an individual instead of one that is new. The people who do this are bypassing Lennar's entire product mix.

References

1. ↑ LEN 10-K 2009 Item 1 Pg. 2
2. ↑ MarketWatch - Investors Greet Lennar
3. ↑ LEN 10-K 2009 Item 6 Pg. 22
4. ↑ FY2007 SEC Filing - Regulatory Risk p14
5. ↑ Mortgage Reform and Anti-Predatory Lending Act - Section 204
6. ↑ FY2007 SEC Filing - Homebuilding Market and Economic Risk p10
7. ↑ Builder Magazine - 2006 Builder 100