Lennar’s Gross Margins Fell, Focused on First-Time Homebuyers
What Does Lennar's Strong Fiscal 4Q15 Performance Mean?
Gross margins fell
In the second quarter, Lennar’s (LEN) gross margins rose sequentially by 50 basis points to 24.6%. Last year, the second-quarter gross margins were 25.1%. This was a fall of 100 basis points. The YoY (year-over-year) comparisons tell you much more than the sequential changes. The homebuilding business is very seasonal.
Gross margins are a function of pricing power and costs. While lower oil prices are making materials like asphalt shingles cheaper, skilled labor is scarce and expensive. While rising labor costs might be seen as a negative for Lennar, they should be the catalyst to bring back the first-time homebuyer. Given the pent-up demand in housing, builders are about to enter a secular trend that will drive earnings for years going forward.
Branching out into the hot rental market
We’re seeing a continuing trend in growth in multifamily construction. There have been close to 1.3 million building permits. Lennar is building out its multifamily construction sector to take advantage of the hot rental market. Toll Brothers (TOL) is hitting this area as well. It’s focused more on urban luxury apartments.
Part of the reason for the falling margins is a new focus on the first-time homebuyer and an expectation of more entry-level communities. Lennar isn’t the only builder increasing its focus on the first-time homebuyer. While starter homes may have lower margins, there’s a tremendous need for affordable housing. D.R. Horton (DHI) launched a new brand targeting entry-level buyers. KB Home (KBH) has exposure there as well.
Soon, we’ll hear from PulteGroup (PHM). It’s a large, diversified builder with exposure at the lower price points. An alternative way to invest in the homebuilding sector is through the SPDR S&P Homebuilders ETF (XHB) or the iShares U.S. Home Construction ETF (ITB).
Focus on the first-time homebuyer
Lennar is focusing on the high-end first-time homebuyer and the move-up market. This is why its average selling prices remain higher than D.R. Horton or PulteGroup.
Given the difficult situation that Millennials find themselves in, many have become renters. Lennar has been building out its apartment strategy. It benefited from good timing. Rents are soaring and vacancies remain at historic lows. It’s a good way for the company to take advantage of current conditions and wait for the first-time homebuyer to return.
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