Lennar Lays Out Its '23 Game Plan In 7 Cycle-Tested Strategy Pillars

A good sharp look at certainty.

This is a bona fide bulwark upon which residential real estate either thrives or suffers. It was what so many of the community's invested stakeholders craved. A vortex of sinister global, domestic, and local financial and economic forces swathed certainty in thick, swallowing layers, amplifying doubt and sparking seeds of fear. So, everybody begged for certainty as a marker for better days ahead.

This week it came. Two lenses exposed it, each of them removing uncertainty like tearing off a bandaid.

Responsible for one of them was Federal Reserve chair Jerome Powell, whose pronouncements softened the near-term assault on housing's economic underpinnings only to add severity to the impacts a higher terminal rate for a longer duration would ultimately unleash. But it was no longer grounds for speculation. It was now a certainty that makes clear that if you're not going to "fight the Fed," your reality for the next 12-plus months stacks up to being a fierce thrash  to close homes in the buyer backlog and to bring new ones into the pipeline.

The other lens shone certainty closer to home. Lennar executive chairman Stuart Miller and his executive team yesterday delivered the clearest picture yet of how 2023 will work at the vanguard of a trillion-dollar U.S. homebuilding and new residential development ecosystem at risk of shrinking by $225 billion in the next 12 months.

The challenge now is handling it, because it is going to hurt.

Especially in light of a generationally extraordinary effort and result among homebuilding and residential real estate's business community leading to this juncture.

The Lennar executive team addressed a backward-forward look among investment analysts as it reported 2022 fourth quarter and full-year results, and gave guidance on its Q1 2023 business outlook.

In a two-year crucible of supply-constraining challenges set in motion by Covid, Lennar's performance speaks for itself.

A prepared statement from Lennar's Stuart Miller spells this out:

While supply chain challenges continued to dominate both the homebuilding and the broader economic narrative in the fourth quarter, we are pleased to report record fourth quarter earnings of $1.2 billion, or $3.91 per diluted share, compared to $882.8 million or $2.82 per diluted share for the quarter last year. Excluding mark to market losses on our public strategic technology investments, fourth quarter 2021 earnings were $1.3 billion, or $4.36 per diluted share. For the full year, we delivered just under 60,000 homes generating EPS of $14.27 per diluted share ($13.00 per diluted share before mark to market gains) for an 82% increase over the prior year (66% before mark to market gains)."

"Our record fourth quarter results reflect both continued strength in the housing market across the country, and continued housing supply shortage driven by limited entitled land, labor and supply chain constraints, and 10 years of production shortfall. While our new orders grew a controlled 2% compared to last year's seasonally strong fourth quarter, we achieved a homebuilding gross margin of 28.0% and homebuilding SG&A of 6.0%, leading to a 22.0% net margin, all of which are all-time Company records."

In anyone's book, this summary reflects a Lennar culture of driven capability, and an organizational ecosystem of partners both aligned and equally bent on overcoming challenges.

Miller in remarks to analysts yesterday [from SeekingAlpha] takes pains to clarify that the 2022 accomplishments and the 2023 and beyond masterplan for financial and operational initiatives all date back to well before difficulties began to emerge even with the onset of Covid in 2020. What's more, the masterplan, or "strategy playbook," as Miller calls Lennar's holistic seven-pillar strategy, keeps the enterprise playing "on offense" into next year and beyond, rather than pivoting to a prevent defensive gameplan.

Forged before either the irrational exuberance of late 2020 through early 2022, or the pulverizing pessimism laying hold to many markets in today's, the Lennar strategy playbook – for the organization's own stakeholders and for an entire ecosystem of partners, rivals, and multiplier-effect players – pierces through uncertainty, come what may.

Come what may, by Stuart Miller's lights, could mean that as much as a third of all ground-up residential construction in 2022 could vanish from new single- and multifamily housing starts for 2023. Even amid such a heavy hit to the national new homebuilding and development landscape, Lennar's stated plan of the moment is to produce, sell, and close homes both profitably and at a rate roughly flat with 2021 and 2022 production levels.

Both its aggressive production and deliveries outlook and its determinism around healthy profitability spring from confident resolve around an unswerving execution on Lennar's seven strategic pillars.

The playbook pillars – in shorthand fashion - map out as follows. Underlying them all, Miller notes, is the broad theme that Lennar will use a generationally strong 2022 Gross Profit Margin as a temporary "shock-absorber," allowing it to shrink in order to effect a pan-ecosystem commitment to and investment in making a go of it in much more adverse conditions:

• Leveraging a secret-sauce dynamic pricing model and a proprietary Digits – Microsoft-backed – marketing platform to detect and act on a strike price that stays in constant real-time motion, driving matches between homes and buyers on a fine-tuned, constant-forward-moving level.
• Right-size cost structure, leveraging scale, volume visibility, local market heft, to forcibly ratchet down trade, land, and vendor expense so that everybody in Lennar's system bears some measure of the weight of more adverse
• In the same vein, Lennar's ongoing dynamic plans call for resets on what it pays and will pay for land and lots, ensuring that deltas between lot price and vertical development and sale prices re-hitch in 2023's new realities.
• Internally, Lennar's focus on its corporate overheads and operating costs will mean additional corporate-level cost cuts, even as cost-of-sales that fund incentives rise, will be in the plan.
• Evenflow, Lennar's discipline around controlling a precise balance between starts, sales, and closings – i.e. currently a reported 900 completed unsold homes are in Lennar's inventory pipeline, roughly one home per actively selling community. This ties to balance sheet impacts of Lennar's inventory turns that have been bloated over the past couple of years due to supply chain and construction cycle time delays. Net, net, Lennar expects catch-up in 2023 to free $150 million inventory into cash, and as well, by pausing 2023 growth (i.e. staying flat year to year), generating added cash.
• Focus on driving cash flow to bottom line profits, improving cash position and balance sheet to sustain resiliency and optionality.
• Transparency in telegraphing a "miss." A strategic miss for 2022/23, Miller concedes, is a plan to spin Quarterra – its broader real estate development platform – into its own public company, leaving Lennar as a pure-play vertical homebuilding, marketing, selling, and consumer experience enterprise.

Here are a few highlight verbatim comments from Lennar executive chairman Miller and a couple of key executives, noteworthy not just as insight into what America's second-ranked homebuilding enterprise plans for 2023 and beyond, but equally as important, what that means to competitors.

On the 2023 Downturn – Steep But Short

Stuart Miller, Executive Chairman

We could look at some of the larger builders, and I'm sure that they'll adjust their start pace and no one has been asleep at the switch in the industry – a lot of very smart participants. But there are some practical realities relative to smaller builders across the country. Remember, the larger builders are that we make a proportion. And the capital markets are complicated right now. It's not just a question of strategy for some. It's a question of what can you actually get started and how are the capital markets supporting it. I think that it might be only 10% or 20% or 30%. I don't know what the percentage is going to be. My personal view is that it looks like many of the smaller builders are really pulled back, the complication of price reductions and what's been paid for land and stuff like that.

The other side of it, which makes up about a third of production is multifamily. And the multifamily capital markets are very frozen up right now. I think that the number of new communities coming out of the ground for multifamily and even the single-family for rent buyers are kind of seized up because of capital markets considerations. So, let's not even throw in strategy just from a capital market standpoint, it feels to me, can't prove that, a very sizable portion of starts for next year are going to be under limitation.

Now, if it ends up being only 10% instead of 25%, still, you're looking at a housing shortage. I know that there are many with different opinions on this. I believe there's been a production shortage, housing shortage across the country. If you talk to mayors and governors across the country, their single biggest concern is workforce housing supply and affordability. It is a drumbeat that is in almost every major city and every state. And we feel that there is a shortage that is going to be compounded by the fact that there will be some production and reduction out of this and whether 10% or 35%, it's still going to be short supply, and I think a more limited downturn.

On Lennar's 2023 Sales Pace

Rick Beckwitt, Co-CEO/Co-President

We're going to keep the machine going and feel that from an overhead and operational standpoint we get greater leverage by keeping that sales active. We know it's above where we were in 2019 from a pace standpoint and our focus is to keep and maintain that pace as we move forward into 2023."

Stuart Miller, Executive chairman

I think you can expect a lot of consistency. I probably haven't spent enough time talking about our dynamic pricing model, but it is really at the core of how we're running our business, and we're doing it on a day-by-day basis, focusing on how do we get the right pricing for the customer base for today's affordability to maintain that sales pace. I think you're going to continue to see us working hard in that direction.

As I noted, it has the ancillary business of informing our land banking pipeline, but the dependability they expected is the dependability they'll get. And we're moving through our pipeline of higher-priced land that was priced or bought to yesterday's pricing, and we'll be bringing in land that is more appropriately priced to current market conditions. All of this kind of works synergistically to really inform us to keep that volume and that sales pace consistent."

On Forcing Labor, Materials, Land Costs Downward:

Stuart Miller, Executive Chairman

Make no mistake, Lennar led the way with reduction in margin, while maintaining volume and increasing market share as the market has corrected. We expect our trade partners to work side by side with us and follow suit.

As margins expand -- expanded in the best of times, they benefited; and as margins have now contracted in the more difficult times, we are driving costs down as prices are reduced and we expect participation as well. While there is no doubt a lag in those reductions coming through our -- there is no doubt, a lag in those reductions coming through our reported numbers; there will also be no doubt a significant reduction coming, period. Cost reductions will improve lagging margins.

Jon Jaffe, Co-CEO/Co-President

We started the reconciliation process with land. Remember, our land position is much shorter term than it's been in past. And therefore, we have flexibility. And so, we think that we'll be able to reconcile some land pricing. And as far as our trade partners are concerned, I think I was clear, we've been working with trade partners, both on labor and material. Some of those materials like lumber are already filtering through, just at the very early stages filtering through some of the price reductions that will build as we go through the year. But we are working hand in hand with our partners.

And given our volume and pickup in market share, there's a lot of labor, a lot of other people out there that are looking to do business with us. We think we'll be able to bring our pricing down.

Rick Beckwitt, Co-CEO/Co-President

You really can't underestimate the leverage that we get in working with our trade partners as things slow down across the board. People are looking for work. If we're going to be the ones out there to do -- starting homes, we're going to get cost concessions, bringing cost concessions from our trade partners, from our land partners, and we're just going to continue, as Jon said, value engineer and re-specify product in order to make it more affordable, so we can have more higher margins.

On Lennar's Resilient Operational-Financial Model

Stuart Miller

We have been reducing our SG&A to extremely low levels so that as margins come down, we're still producing cash and we're producing profit and bottom line. But at the same time, it enables us in tougher time to continue turning our inventory, turning our land inventory, as I noted, our higher price purchased to yesterday's pricing land inventory. We will continue turning that. It is cash productive and we'll redeploy that into repriced land purchases for the future. All of this is symbiotic and works to drive cash flows, replenish inventory appropriately positioned while keeping the trains running on time and generating cash flow, improving the balance sheet and maintaining profitability. So, that is basically the game plan."

If things are worse than expected in 2023

Stuart Miller

We've been preparing for this for quite a long time. We have been focused on building efficiencies, sticky efficiencies into our SG&A, especially at the division level over the past years, quarter-by-quarter, basis points by basis points, we have been refining, reducing the cost of doing business. I think that if market conditions were to continue to deteriorate, we're going to continue to lean into the consistent program going forward. We have a lot of room to be able to make those adjustments. I think that there's been some concern about notions of impairment. There might be some modest impairments that flow through with further deterioration, but it's not going to be the significant kind of programming that you've seen in the past. I think we've got really terrific shock absorbers within our operating platform to be able to continue the program even as -- even if you look at a downside scenario, we'll continue to be building and volume focused through alterations of the market.

On Dynamic Pricing

Dianne Bessette, CFO

It's a home-by-home assessment, each home, each community, each market, and the tool looks -- of what we've sold that exact plan for over time. And it also looks at the market competition for that plan in that community in that market. So, it's a lot of detail, but the point is it truly gives us an unbelievable amount of real-time detailed information because that's really the only way that you can price. We talk about it at a very high level, but pricing really is at a planned community market level. And it allows us to be really flexible when pricing is going up as well as pricing is going down. We use the tool in all market conditions."

It's no secret that just as the years 2007 to 2010 were far more catastrophic to privately-held homebuilding entities than the nation's largest players, the potential negative hits to private builders in the next 12 to 24 months once again will likely be materially consequential.

So, while homebuilders and their partners got a double-dose of certainty this week – from the Fed and from one of the space's market-maker players – the question now is, can they handle the certainty?