Lennar, Spec Homes, and Balance

Implications: Homebuilders are employing differing speculative inventory strategies in the market today. Lennar's is driving home prices down further. This artcile explores Lennar's strategy and other strategies being employed.

Analysis: Speculative building continues to drive home prices down for some builders, and in most cases, entire market areas where builders with significant inventories are currently operating. Why then, would some builders continue to produce homes buyers seem to have enough of? The answer is not a simple one. Some inventories are the result of buyer cancellations. Others are intentional, out of what builders believe is necessity. And, still others, it seems, are the result of builders simply wanting to keep the machine moving rather than slowing.

Inventory homes are arguably necessary for any builder wanting to sell a new home today. In the Phoenix metro area, constructing a home usually takes 4 to 6 months. A volatile lending environment, oversaturated resale market, falling home values, and buyers’ perceptions of the market, increase the likelihood of cancellations as closing on a new home approaches. Builders selling “new build” homes have experienced exceptionally high cancellation rates; the 4 to 6 month construction time seems to be enough time for something to cause the seller to cancel the home purchase. Those builders selling spec homes, on the other hand, are experiencing far lower cancellation rates, as they sell and close within a relatively short period of time passing.

Some speculative building is necessary to produce cash flow today - as many builders believe. A reasonable number of spec units, perhaps up to 4 homes at various stages of construction, seem to fit today’s environment. The variation in completion times allows for builders to serve a particular buyer’s needs versus the builder feeling the need to “fire sale” homes.

Baffling those following the market closely, one publicly-traded home builder, Lennar, has continued to pump out spec homes, despite its stated strategy of keeping inventories down. Two weeks ago, Stuart Miller, Chief Executive of Lennar, announced, “Our response to, and primary focus in, this environment continues to be to adjust pricing to meet current market conditions in order to keep inventories low and to keep our balance sheet positioned for the future. The net effect has been a continued deterioration of our net margin and accordingly, higher impairments to our inventory.” Lennar’s strategy, according to internal personnel BREC has spoken with, is to sell only spec homes, particularly those that are 30 to 60 days from completion. Many of Lennar’s Phoenix communities have 5 to 10 spec homes within 60 days of completion and several more under construction. As long as such a strategy is employed, Lennar, and likely home sellers (builders and resellers) selling homes nearby Lennar communities, can expect to continue experiencing declines in home values.

Regardless of your strategy as a builder, or the strategy of the builders you are selling lots to or following, incorporating an appropriate speculative building strategy can be the difference between selling homes or not selling homes today. Equally important, is understanding the strategy of those selling nearby. For those building near home builders like Lennar, prices may be forced lower as a result of excessive new home inventory.