Posted on Wednesday, November 17, 2010
Since the collapse of the housing market most home-builders have had to implement survival strategies, but none has been more aggressive and successful than Lennar. Judging by recent deals and Lennar's plans to raise large amounts of capital for its investment unit, the company is focusing on distressed asset investments, including commercial assets, and on land banking. For now, it's residential development operation is secondary to its investment strategy.
"Their home-building business is not going anywhere for a while," said David Dabby, a real estate consultant in Miami.
According to Dabby and other analysts, Lennar's recent moves are part of a strategy to take advantage of the real estate downturn, keep profits flowing and gear up for a strong come back when the market starts to recover.
"There is a lack of demand for new product and since they are home-builders the only way to compensate for that is to do deals ¬— land, acquisition, disposition, note purchases, note sales, buying distressed commercial real estate — anything to move and shake — and they are pretty good at it," Dabby said.
Lennar chief executive officer Stuart Miller said at a home-building conference last week in New York that the company plans to raise $750 million and invest about $500 million in distressed assets through its Rialto unit.
A first tranche of the offering is being marketed to U.S. and Canadian investors and is expected to close by the end of November.
Lennar and Rialto executives did not return calls seeking comment.
Lennar formed Rialto in 2007 with a group of executives who worked for LNR Property, a former Lennar unit that acquired distressed assets from the government almost two decades ago. LNR was a crucial part of Lennar, accounting for about half of Lennar's net income in the mid-1990s.
Rialto hasn't reached LNR's level yet, but it is aggressively pursuing distressed deals. In late September, Rialto acquired $740 million in problem loans and real estate from three large financial institutions. The assets included about 400 loans backed by residential and commercial properties totaling about $529 million. Most of the loans are nonperforming.
The acquisition also included 306 bank-owned properties with a total appraised value of $221 million. According to filings with the Securities and Exchange Commission, Lennar paid $310 million for the loan portfolio and the real estate assets. The properties consist of land and both single-family and multifamily communities.
In February, Rialto partnered with the FDIC and paid $243 million for a 40 percent interest in a $3 billion loan portfolio acquired from failed banks.
Rialto's strategy is to buy the assets or loans at a discount and restructure them. The process can be costly and time-consuming. But it can be profitable.
Miller said during last week's conference that each 10 cents of "resolution value over our 40-cent purchase price creates approximately $122 million of profit." Rialto contributed about 26 percent, or $7.7 million, to Lennar's $30 million third-quarter profit, even though the unit only accounted for 4.6 percent of the parent's total revenue during the period.
"They are just adding to their revenue stream," said Robert Rulla, an analyst with Fitch Ratings. "As the housing markets operate under lower levels, in the short to intermediate term, Lennar's Rialto unit provides an additional revenue stream for the company in the form of management fees and income resolution of the distressed real estate assets."
Miller said Lennar is different from its competitors because it has built a "machine" that enables the company to invest where "others are just not equipped to do it."
"Lennar did very well in the '90s with LNR," said Lewis Goodkin, a real estate consultant in Miami. "They've got a lot of experience, and they know this is a good opportunity for them."
"They are perfect for this," he said. "The president of the company is very well versed in all segments, which allows them to diversify."
With its Rialto unit, Lennar has acquired not only residential assets and loans but also commercial properties, including apartment complexes.
Unlike other investors in the distressed market, Lennar also has the opportunity to acquire individual residential sites at deep discounts from Rialto's bulk portfolio, Goodkin said.
That allows Lennar to land bank at much lower prices than its competitors, he said.
"They have the capability of doing something themselves with the assets as opposed to disposing of them," he said.
With so much unsold housing inventory in the market, some experts think it may be too early for Lennar to acquire home-building sites. Goodkin said that at the right price, it can still be a smart move.
Lennar has been investing in geographic areas where it believes a recovery is near.
For example, Miller said in his presentation that the company is targeting areas such as Doral, which he said has a housing inventory that's likely to sell out within a year. That's in contrast to downtown Miami, where the unsold condo inventory is expected to last more than three years.
Lennar recently acquired four development parcels in Doral, including two from Starwood, one from a failed bank and another from a failed local builder, Miller said.
In the third quarter, Lennar purchased 3,300 home sites and put another 900 under contract.
The land acquisitions are being made at prices that would allow the company to build and sell the homes at current market prices, rather than being purchased with the hope that housing prices will increase. The purchase prices also are based on a slow sales pace, Miller said.
"They have been very cautious with their land acquisitions," Rulla said.
Lennar has also taken advantage of affordable credit.
The company said last week that it had arranged for letters of credit totaling about $150 million from a group of lenders headed by JPMorgan Chase Bank. The agreement runs through 2013.
"If you time your buy correctly and borrow at a cheap rate, your cost of holding an asset is then lowered considerably," Goodkin said.
Rulla said that earlier this year Lennar terminated one of its credit facilities because it had enough cash on its books. But because of the attractive borrowing rates, Lennar and other builders have started to secure credit for potential investments.
"It's a good time to issue debt at a favorable rate. We've seen other builders access the capital markets in the last couple of weeks or so," Rulla said. "They will probably use it as down payment for lot options or some other use for their home-building operations."
In the recent conference in New York, Miller said the focus of the company has been in strengthening its balance sheet, while trying to rebuild profitability in its core home-building business.
Lennar last week announced it was selling $435 million in convertible senior notes due in 2020.
Analysts said some of the proceeds from the note sale will likely be used to fund Rialto's acquisitions.
As of the end of the third quarter, Lennar had a cash balance of about $1 billion.
Lennar reported a third-quarter profit of $30 million, compared with a net loss of $171.6 million in the same quarter of 2009.
Lennar has also reduced the number of home-building joint ventures it was involved with and the amount of recourse debt from those joint ventures. For example, Lennar had more than $1.7 billion in recourse debt exposure in these joint ventures. That has been reduced to about $180 million, according to the company.
Rulla said he expects Lennar will continue its strategy to bolster its financials, build market share by purchasing land and capitalize on distressed assets.
Miller said it's no secret the company wants to raise capital for investments.
"We will raise capital in the public market. We will raise capital through private avenues as well. Capital wants to invest where there are outsized returns. There are outsized returns in the investment vehicles," he said in a Sept. 20 conference call with analysts.
"We are comfortable that with the capital we have on our balance sheet and our access to capital right now outside of the company, we are going to be able to make a lot of investment opportunities come to fruition."
The company is focusing on distressed asset investments, including commercial assets, and on land banking. For now, its residential development operation seems secondary to its investment strategy.
According to analysts, Lennar's recent moves are part of a strategy to take advantage of the real estate downturn, keep profits flowing and gear up for a strong come back when the market starts to recover.Polyana da Costa
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