Summary
The US housing market is slowing down after a decade-long boom due to high mortgage rates, rising prices, and inventory shortages. As a result, potential recession and foreclosures pose concerns.
The US housing market has grown steadily, with outstanding mortgage debt and rental demand increasing.
The homeownership rate has risen slightly, and mortgage originations and refinances forecasts have been elevated.
Lennar aims to maintain sales volume using incentives and dynamic pricing with a strong digital marketing platform.
Lennar's construction strategy focuses on reducing costs, minimizing cycle time, and achieving even flow production.
Aerial Shot of Suburban Development
Investment Thesis
In this housing market series, we will revisit the market's outlook as well as the performance and future prospects of Lennar Corporation (NYSE:LEN), which since my last coverage, has returned an impressive 54% despite the growing concerns and challenges in the market over that period.
Lennar is well-positioned to weather the challenges facing the US housing market thanks to its robust digital marketing platform, cost-efficient construction strategy, and focus on reducing cycle time. In addition, the company's incentives, dynamic pricing strategy, and high demand for rental properties are expected to maintain sales volume.
Additionally, the growth in the mortgage market suggests a consistent demand for property investment, which bodes well for Lennar's long-term prospects. The recent increase in the homeownership rate and the positive signs of growth in the new home sales market are also favorable indicators for Lennar's future performance.
Over the past 12 months, Lennar has strongly outperformed the S&P 500 (SPY) and SPDR S&P Homebuilders ETF (XHB). Still, the strong bull run has brought LEN closer to its fair value, suggesting limited upside potential for the stock, leading to my hold rating for the foreseeable future.
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Housing Market Outlook
The US housing market is experiencing a significant slowdown in 2023 after a decade-long boom. The market faces challenges due to high mortgage rates, rising home prices, and a persisting inventory shortage driving up demand. In March, median home sales prices decreased by 0.9% to $375.7K, with total existing-home sales dropping by 2.4% from February to March and 22% from the previous year, supporting the undersupplied status of the market.
However, home prices are projected to decline nationally by 1.2% in 2023, followed by a further decline of 2.2% in 2024. Mortgage rates have increased to 6.43%, and the Federal Housing Finance Agency has imposed higher fees on conventional mortgage borrowers who put down between 5% and 25%.
Lennar Corporation, LEN, Housing market trends, real estate prices, mortgage rates, homeownership rates, housing inventory, property values, home sales data, new construction homes, affordable housing, housing affordability, foreclosure rates, rental market trends, property taxes, housing market forecasts, demographics and housing,
As a result, mortgage application activity remains low, nearly 28% below last year's pace. However, economists predict that inflation deceleration could lead to gently declining rates in 2023, which could benefit borrowers looking to purchase a home. However, while the mortgage market remains strong, its size relative to GDP has decreased. In 2022, the mortgage market's size was equivalent to 77.2% of GDP, down from 78.5% in 2021 and 80.4% in 2020.
The housing market's inventory problem is also a significant challenge, with supply remaining near historic lows. However, at 4.2 million, the 2023 existing home sales forecast is the slowest pace since 2010. The supply of homes for sale at the end of March was 60% higher than a year ago but remained at half the pre-pandemic inventory level. However, the Federal Reserve's ongoing rate hikes and elevated mortgage rates discourage homeowners from selling and could make builders reluctant to start new projects.
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Notably, there is a low probability of a housing market crash in 2023, but a recession or stagflation poses concerns for the near-term market outlook. Foreclosures are up 22% YoY and 6% QoQ in Q1 2023, following the expiration of the COVID-19 foreclosure moratorium in September 2021. The upward trend in unemployment rates, foreclosure filings still being processed after two years of government intervention, and persistent economic difficulties all contribute to this situation.
Overall, the US housing market in 2023 may face challenges due to high mortgage rates, rising home prices, a shortage of inventory, and a significant slowdown after a decade-long boom. However, concerns about a recession or stagflation in the near-term market outlook overshadow the low probability of a housing market crash.
Growth Ahead For The Housing Market
The US housing market grew steadily over the past five years, with outstanding mortgage debt reaching $19.33 trillion in 2022, marking a YoY increase of 7.04%. The most significant share of outstanding mortgage loans is held by one- to four-family residences, almost 70% of the market.
Notably, the consistent growth in the mortgage market suggests that demand for home ownership and property investment is resilient in the US over the long term. While single-family construction starts enhanced by 2.7% in March 2023, building permit applications increased by 4.1%, and a point boosted builder confidence, the demand for new homes is expanding.
Additionally, the demand for rental properties has been increasing, with the median asking rent rising by 7.5% year-on-year to $1,307 monthly in 2022, the highest recorded level ever. As a result, rental properties are in high demand, and rental prices are expected to continue to rise. Furthermore, the rental vacancy rate in the US fell to 5.8% in 2022, the lowest level seen since 1997.
Further, the US homeownership rate increased slightly to 66.0% in Q1 2023, up from 65.9% in Q4 2022, the highest since Q3 2020. The Midwest region had the highest rate at 70.1%, while the South region declined to 66.7%. Meanwhile, the Northeast and West regions experienced an increase in homeownership, with rates of 63% and 62.6%, respectively. Moreover, the new home sales market also shows some positive signs of growth, as seen in the seasonally adjusted annual rate of 683K in March 2023 (+9.6% MoM), up from the previous month's rate of 623K.
Lennar Corporation, LEN, Housing market trends, real estate prices, mortgage rates, homeownership rates, housing inventory, property values, home sales data, new construction homes, affordable housing, housing affordability, foreclosure rates, rental market trends, property taxes, housing market forecasts, demographics and housing,
However, there was still a decline of 3.4% from the March 2022 estimate, indicating that the market is growing slower than in the previous year. The March 2023 median price of new homes sold was $449.8K, which is relatively high compared to last year. The average sales price of $562.4K suggests a market for higher-priced new homes. Also, as per FNM-HPI, home prices rose 1.0% in Q1 2023 from Q4 2022 on a seasonally adjusted basis, reflecting resilient homebuyer demand, with prices up 4.7% annually.
As of March, the seasonally adjusted calculation of newly constructed homes available for purchase was 432K, indicating a supply that can last for 7.6 months based on the current sales rate. It suggests that a relatively healthy inventory of new homes is still available for purchase.
Furthermore, due to home sales and price upgrades, Fannie Mae has upgraded its forecast for single-family purchase mortgage originations in 2023 and 2024 to be $1.3 trillion and $1.4 trillion, respectively. Refinance forecasts have also been upgraded due to lower mortgage rates this month, with refinances expected to be $312 billion in 2023 and $584 billion in 2024.
Lennar Corporation, LEN, Housing market trends, real estate prices, mortgage rates, homeownership rates, housing inventory, property values, home sales data, new construction homes, affordable housing, housing affordability, foreclosure rates, rental market trends, property taxes, housing market forecasts, demographics and housing,
The US housing market has been growing consistently over the past five years, with both outstanding mortgage debt and rental demand increasing. While the homeownership rate has risen slightly, existing home sales remain slow, and the supply of homes for sale is only at half the pre-pandemic level.
However, recent home prices have been resilient, and mortgage originations and refinance forecasts have been elevated. Overall, the housing market is stabilizing after pandemic-induced volatility, and the market is expected to return to a pre-pandemic historical norm by the second half of 2024.
Lennar's Q1 Overview
Lennar is navigating a volatile macroeconomic environment. Despite facing headwinds due to rising interest rates and inflation concerns, Lennar aims to maintain its sales volume while using incentives and sales prices as shock absorbers to manage market volatility.
Although interest rates have been a primary challenge for sales activity, Lennar believes the housing market begins to stabilize as customers become accustomed to higher interest rates. However, the overall housing shortage remains a driving force, as the US housing market is underbuilt by 6.5 million units which has persisted for over a decade since the Great Recession. However, over time, this shortage should help stabilize the housing market.
Although the cancellation rate improved to 22%, it was still higher than last year's 10%. Specifically, the cancellation rate declined from 26% in the fourth quarter to 21% in the first quarter, with sequential improvement in each month of the quarter. For example, in February, the cancellation rate was 14%, much lower than the normalized rate. In addition, the company's new order sales price in the first quarter was $452K, an increase of 8% from the fourth quarter due to a more favorable mix.
Lennar Corporation, LEN, Housing market trends, real estate prices, mortgage rates, homeownership rates, housing inventory, property values, home sales data, new construction homes, affordable housing, housing affordability, foreclosure rates, rental market trends, property taxes, housing market forecasts, demographics and housing,
Moreover, new orders were down by 10% year-over-year, but the company's strong start pace enabled it to increase its expected closings for the year to a range of 62K to 66K homes delivered. Despite limited new home inventory, homeowners are holding on to extremely low mortgage rates and minimal multifamily production, leaving the industry in the middle of a reasonably short-duration correction without an inventory overhang to resolve. As the correction develops, these factors will extend the runway for longer-term housing growth.
Lennar is confident in its ability to achieve sales at the best possible prices thanks to its significant investment in digital marketing, which has become more relevant than ever. The company's dynamic pricing model and robust and improving digital marketing platform allow it to continue driving sales volume at market-clearing prices while maintaining consistent production levels.
Lastly, Lennar's proprietary Digits platform provides digital marketing insights and analytics that guide the company to better execution while maximizing pricing using its dynamic pricing model.
Margins Are Falling
Higher mortgage rates impacted the housing market by reducing affordability and homebuyer confidence. As a result, the company had to adjust its base prices, increase incentives, and provide mortgage buy-downs to maintain its targeted sales pace.
In the first quarter, the company's new sales orders decreased by 10% from the previous year. However, the decrease is considered favorable (as compared to adverse market conditions), reflecting the successful implementation of the price-to-market strategy. In addition, despite the drop, new sales orders increased sequentially from the fourth quarter and each month of the first quarter.
Unsurprisingly, this strategy required sacrificing gross margins to generate sales. Lennar used a dynamic pricing model to quickly determine the market-clearing price for each home on a community-by-community basis. As a result, during Q1 2023, Lennar's margins fell to 21.2% due to the use of price reductions and incentives to offset volatile interest rates and market shifts.
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Flexibility Through An Asset-Lighter Model
Lennar is committed to quickly addressing future market changes as the company's markets remain fluid. The company's balance sheet and inventory management progress was driven by its execution of a land strategy while simultaneously reducing its community count.
Specifically, Lennar has access to many land sites, allowing the company to meet demand while having financial flexibility without locking capital into owned lands. By owning less land and relying more on a land options strategy to acquire property on a just-in-time basis, allows the firm to generate more cash flows and returns on invested capital. Lennar controlled nearly 68% of total home sites for the recent quarter ended, and as the company reduces tied-up capital and has more liquidity, it can protect the downside from any impending market shock.
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Data by YCharts
Optimized Construction Strategy
Lennar focuses on maintaining a consistent sales pace and effectively managing inventory by matching sales with start-up space. In the first quarter, this strategy resulted in only about one home per community ending inventory.
The company's construction strategy involves reducing construction costs, minimizing cycle time, and achieving even flow production. In the first quarter, construction costs decreased sequentially by approximately 1% due to last summer's reduced lumber costs. However, year-over-year construction costs rose by almost 13%, reflecting the high-cost environment for home construction.
Lennar has been taking measures to decrease expenses, such as collaborating with their trade partners to lessen labor and material costs, reviewing all their product lines for suitable specification modifications, and implementing a constant value engineering review process across all their divisions. As a result, they have identified savings of $14K per home in construction costs which will reflect in their closings in the latter half of the year. While navigating the challenging inflationary pressures on certain material costs, they are making further progress toward identifying more savings.
Cycle time is another critical aspect of Lennar's construction strategy. The company experienced extended cycle times in the first quarter due to supply chain challenges in the second half of 2022. However, they plan to eliminate those homes with longer durations from their inventory by closing more of the homes they started last year, which were heavily impacted by supply chain disruptions. As a result, the company reduced front-end cycle time by over two weeks from its peak by the end of the first quarter and is on pace to improve cycle time by a few days each week. Over the coming quarters, the cycle time reduction will release substantial cash currently held up in their inventory. This will lead to a further improvement in the balance sheet.
Even flow production is Lennar's construction strategy's third area of focus. The company aims to achieve consistent completions throughout the month and quarter, allowing them and their trade partners to be staffed on average, avoiding inefficiencies.
The declining starts and the drop in building permits, which are proxies for a further decline in future starts, have already and will continue to free up the availability of labor and materials. In addition, Lennar's trade partners understand the company's steps to keep their sales pace and support their volume and are partnering with Lennar to lower their construction costs. As a result, the company expects to start seeing these savings flow through their second-quarter closings, which are factored into their margin guidance.
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Data by YCharts
Takeaway
In conclusion, the US housing market 2023 faces several challenges, including a significant slowdown after a decade-long boom, rising mortgage rates, an inventory shortage, and potential economic uncertainties. However, the housing market's long-term prospects remain strong, with consistent growth in the mortgage market indicating continued demand for homeownership and property investment.
Lennar's robust digital marketing platform, cost-efficient construction strategy, and focus on reducing cycle time support the company's resilience to weather the current housing market challenges. In addition, its incentives and dynamic pricing strategy, combined with the high demand for rental properties, are expected to maintain sales volume. Last, the short-term uncertainties, the US housing market's resilience, and steady historical growth suggest a positive outlook.
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