Lennar: Anything But Just A Simple Homebuilder

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Lennar ( LEN ) is kicking up a lot of dirt on the homebuilding front.

It's working on orders for new homes, which soared 40% in the quarter ended in May, and more following as the industry awakens from a long sleep.

Miami-based Lennar is one of the nation's top homebuilders with operations in 18 states and an industry-leading market value of $6 billion.

But it's Lennar's behind-the-scenes work in complex real estate finance and services that's given it extra clout and firepower and sparked intense interest.

It comes from Lennar's newest segment, Rialto Investments, which acquires and monetizes distressed loans and securities.

The business also provides advisory services, due diligence, workouts and asset management services.

Rialto is in some ways similar to LNR Property, a business Lennar spun off in the late 1990s. A former LNR executive, Jeff Krasnoff, oversees Rialto and its staff of 200.

"The biggest difference that sets Lennar apart from its peers is Rialto," said Michael Kim, managing director and partner at CRT Capital Group. "It provides them with a competitive advantage."

That advantage comes from visibility into "transaction activity going on across the country" as Rialto deals with distressed loans with exposure to residential and commercial assets.

Toll Bros. ( TOL ) has a somewhat similar, but smaller version in its Gibraltar Capital and Asset Management subsidiary.

For Sale Sign

LNR is reportedly for sale by current owners Cerberus Capital Management,Vornado Real Trust ( VNO ) andiStar Financial ( SFI ), among others. And Rialto, ironically, is said to be one of the bidders. Lennar did not respond to an interview request.

Whatever the outcome, LNR's sale would give more insight into Rialto's valuation.

Rialto has been particularly helpful in Lennar's pursuit of good land deals.

"We are fishing in a different pond," Lennar's President Richard Beckwitt told analysts in a second-quarter conference call. "We have created many deep-rooted relationships with banks and other local sellers that provide us access to deals that are not on the open market."

And more than just land, Rialto has given the company expertise to buy assets that will turn into land, such as Community Development District bonds, bank notes and mortgages, he added. "This provides us with a constant stream of high-margin opportunities."

So Rialto's relatively weak contribution to Lennar's earnings in the last quarter may be excused, as some analysts have done. And in any event, management says it's a temporary blip.

Rialto's operating earnings in the quarter dropped to $4.3 million from $9.8 million in the earlier year, due to what Krasnoff described in the call as "obstinate positions" taken by borrowers and guarantors of early distressed debt portfolios in repaying their loans.

Until revenue is recognized "later in the process," costs involved in resolutions are expensed upfront, he noted.

Rialto's first transaction, in February 2010, was a 40% managing equity interest in a portfolio of distressed commercial and residential loans held by the FDIC.

Rialto paid $243 million for its share of the partnership. It's still working to resolve some of those distressed assets, says Robert Rulla, a director with Fitch Ratings.

Rialto also invested in a fund formed under the federal government's Public-Private Investment Program, or PPIP, focused on buying securities backed by real estate loans.

In September 2010, Rialto acquired $740 million of distressed real estate assets from three financial institutions, paying $310 million.

Harvesting Byproducts

Since Rialto's early investments in 2010, it's been "harvesting the byproducts of its efforts," Fitch Ratings wrote in a July 17 ratings note, which was generally positive.

A month earlier, Fitch gave Rialto its first CMBS (commercial mortgage-backed securities) "special servicer" rating, a credential that LNR already enjoys. LNR is a major servicer of distressed CMBS loans.

"We have already established Rialto as a leader in today's mortgage-backed securities marketplace," Krasnoff told analysts in the call. "And for those of you who remember what we did with LNR, we expect these activities to open up new opportunities for us to add further to our existing book of business."

Fitch premised its initial rating on Rialto's "management team, asset management capabilities, investment in technology and ability to leverage its parent Lennar Corp."

"Rialto is now a self-supporting business," said Rulla in a phone interview Wednesday.

Rialto is in the process of raising money for a second real estate investment fund to invest in distressed assets and securities.

Earlier this year, Rialto raised $132 million commercial mortgage-backed securities backed by a mix of nonperforming and performing loans and owned real estate.

Collateral Pool

"This is the first CMBS transaction of its kind in quite some time, where the collateral pool was backed by distressed real estate assets. It was a very innovative transaction," Kim said.

Not the smallest part of Lennar's business, of course, is homebuilding. Revenue from core home sales in its second fiscal quarter ending May 31 rose 23% to $796.4 million from the year earlier.

The gain was mostly due to a 20% rise in home deliveries and a 2% uptick in the average sales price, to $250,000.

Lennar logged 4,481 new orders in the quarter, up 40% from the year prior. Backlog stood at 3,970 homes, up 61%.

Gross margins rose to 22.5% from 19.4% in the earlier year, due in part to lower incentives to buyers and higher selling prices as demand rose.

Lennar's earnings got a big boost from another complicated financial maneuver.

Because it had been profitable for nine straight quarters and was confident of future profitability, Lennar reversed $403 million, or $1.85 per share, of a deferred tax asset valuation allowance, which in effect offset income taxes.

So it earned $2.06 as share in the quarter vs. 7 cents the year earlier. It would have been 21 cents without the tax benefit, still 4 cents above Wall Street views.

Lennar expects to reverse its remaining $177 million allowance in the third and fourth quarters.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: LEN , SFI , TOL , VNO

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