Another Winner in the Red-Hot Housing Market

There's a buyer frenzy raging in real estate...

In July, we wrote that the housing market was booming after being briefly slowed by the COVID-19 pandemic. Mortgage applications for purchases, new home sales, and homebuilder sentiment had all surged from their April lows through June.

Since then, the data have gotten even stronger...

In July (the most recent data available), new home sales hit the highest level since December 2006. And homebuilders expect the high demand to continue...

Housing starts and building permits, two closely followed measures of new home construction, surged 22.6% and 18.8%, respectively, in July. This indicates that builders are preparing for a period of elevated demand for new homes.

The National Association of Home Builders' ("NAHB") Housing Market Index, which measures sentiment in the industry, hit its highest level ever in August – matching the December 1998 record. With mortgage rates at an all-time low, NAHB Chairman Chuck Fowke said buyer traffic is at an all-time high as a result.

And that's all great news for today's company...

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 $400,000 in 2019. But it does more than just building and selling homes...

Amazingly, the company captures 78% of the loans on those homes. That means the company makes money on the homes themselves... and on the financing.

It maintained that loan-capture rate through 2019 while reducing staff in that segment of the company by 50%. It was able to do that by incorporating new technology into its sales process.

The results have been staggering. In the fourth quarter of 2018, the financial services segment of Lennar brought in $164 million. In the same period in 2019, it brought in $253 million.

That's jaw-dropping 54% growth.

The company has done a great job controlling spending, too. Last year, its direct costs of building homes went up less than 1%. That's less than the rate of inflation. So costs are staying in line.

And Lennar is focusing on becoming more "asset light"...

This is something we've covered with one of Lennar's chief competitors, NVR (NVR) – the company that changed the game when it figured out a better way to go about homebuilding.

For many homebuilders, their business model needs a lot of capital. First, you find some land you'd like to develop and buy it up. You need the capital right away to pay for the purchase. Now, you've got to work and wait to get the land permitted and developed before you can build on it. You're talking about a lot of time and lot more money.

Instead of spending money buying up land and lots, NVR buys land options. It pays a deposit up front to hold a lot. Then, when it's ready to build a home, it exercises the option and buys the lot.

It 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 is following this model now, too. The company has been making it a point to buy less land outright and enter into more options agreements.

Today, Lennar has options to buy more than 90,000 lots – up from roughly 35,000 two years ago. And its options have grown from less than 20% of its total lots to nearly 30%.

In short, Lennar is going asset-light. And it plans to continue that trajectory in the coming years.

This change is already showing up in the company's profitability. Two years ago, Lennar's return on equity ("ROE") was 9%. Today, it's 13.2%. And return on assets ("ROA") jumped from 4.1% to 7.1% over the same period.

Those are solid improvements. If Lennar continues to focus on options, ROE and ROA should continue to rise.

And that is helping the company ride the red-hot housing market.

Since bottoming with the rest of the market, Lennar shares have soared. The stock has surged more than 150% since its March 23 low, and recently hit a fresh all-time high. That dwarfs the 53% return for the S&P 500 over the same period.

The housing market is booming, boosted by record-low mortgage rates. That should continue to strengthen Lennar's sales in the coming quarters. And its commitment to shifting to an asset-light approach should help propel the stock even higher.

Sometimes investing is simple.