With Limited Supply and Surging Demand, This Business Isn't Peaking Yet

Short sellers on Wall Street keep trying to call the top in the housing market...

Housing bears are pointing to recent declines in month-over-month housing sales growth and surging home prices. And now, with the Federal Reserve teasing future rate hikes, mortgage rates could move higher from their historical lows. That would raise folks' mortgage payments, driving up the cost of housing further.

But the housing market remains strong...

It's a matter of supply and demand. A recent report from the National Association of Realtors ("NAR") said that the housing market is 5.5 million units short of its historical average.

To close the gap, the NAR said that the housing market would have to run at 2005 levels for a decade. And that year was a historical high for housing starts (they didn't peak until January 2006).

We can see that in recent housing starts and building permits data. While the numbers have been choppy so far in 2021, the last 10 months of data are all higher than any point since the housing crisis. That points to builders ramping up construction in order to meet high demand.

And today's company is in a great position to take advantage of this...

Lennar (NYSE: LEN) is America's largest homebuilder, based on sales. It builds homes in 21 states across the country, with an average selling price of $395,000 in 2020.

But it doesn't just build and sell homes... In many cases, it also handles their mortgages. That means the company makes money on the homes themselves... and on the financing.

Lennar is also adjusting its business model to become more asset-light...

Many homebuilders require a lot of capital. First, they find some land they'd like to develop and buy it up. They need the money right away to pay for the purchase.

But instead of spending money buying up land and lots, Lennar is starting to buy land options (a model pioneered by fellow homebuilder NVR). The company pays a deposit up front to hold a lot. Then, when it's ready to build a home, it exercises the option and buys it.

The homebuilder always has the ability to walk away from the deal with a minor loss or renegotiate the price... And it doesn't waste money buying up huge amounts of assets that could lose value if the market turns.

Lennar has been making it a point to buy less land outright and enter into more options agreements. And it plans to continue that trajectory in the coming years.

What's more, Lennar continues to ride the hot housing market to strong results...

The homebuilder reported second-quarter earnings per share ("EPS") of $2.65 versus the $2.38 estimate. Revenue for the quarter was $6.43 billion, beating the expectation of $6.10 billion. Lennar said that home deliveries were up 14% in the quarter. And new orders rose 32% to 17,157. On a dollar basis, new orders jumped 56% to $7.6 billion.

Lennar's backlog of homes ordered but not yet delivered surged 38% to 24,471 homes. On a dollar basis, the backlog grew 56% to $11 billion.

While both metrics grew on a unit and dollar basis, the strong dollar growth indicates that Lennar was charging higher prices for its homes. We've noted these pressures in the housing market, with home prices soaring. And rising materials costs are making it more expensive to build.

But the strong demand that Lennar is seeing shows it's having no problem pushing these higher costs onto customers.

Executive Chairman Stuart Miller said that the housing market remained "robust" in the second quarter, despite higher interest rates. And co-CEO Rick Beckwitt said that the company continues to close out new communities quicker than expected.

And the strength isn't over yet...

As we said above, the market is still millions of homes short of its historical average. That means builders will have to keep increasing construction to meet demand. That should provide a tailwind for Lennar's orders, as well as its share price.

Sometimes investing is simple.