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Lennar (NYSE:LEN)

Q4 2012 Earnings Call

January 15, 2013 11:00 am ET

Executives

David M. Collins - Principal Accounting Officer and Controller

Stuart A. Miller - Chief Executive Officer, Director, Member of Executive Committee and Member of Independent Directors Committee

Richard Beckwitt - President

Jonathan M. Jaffe - Chief Operating Officer and Vice President

Jeffrey P. Krasnoff - Former Chief Executive Officer, President, Director, Member of Executive Committee and Member of Stock Option Committee

Bruce E. Gross - Chief Financial Officer and Vice President

Analysts

Ivy Lynne Zelman - Zelman & Associates, LLC

David Goldberg - UBS Investment Bank, Research Division

Paul Przybylski - ISI Group Inc., Research Division

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Stephen Kim - Barclays Capital, Research Division

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Rob Hansen - Deutsche Bank AG, Research Division

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Operator

Thank you for standing by, and welcome to Lennar's Fourth Quarter Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Mr. David Collins for the reading of the forward-looking statements.

David M. Collins

Thank you, and good morning, everyone. Today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to Lennar's future business and financial performance. These forward-looking statements may include statements regarding Lennar's business, financial condition, results of operations, cash flows, strategies and prospects. Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any insurance as to actual future results.

Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause Lennar's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described under the caption, Risk Factors, contained in Lennar's annual report on Form 10-K most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.

Operator

I would now like to introduce your conference host, Mr. Stuart Miller, CEO. Sir, you may begin.

Stuart A. Miller

Yes, thank you, and good morning, everyone, joining us for our fourth quarter and year-end 2012 update. We're certainly pleased to share our results with you this morning. I'm joined by Bruce Gross, our Chief Financial Officer; and Dave Collins, our Controller. Additionally, Rick Beckwitt, our President; and Jon Jaffe, our Chief Operating Officer, are with us. And Jeff Krasnoff, as always, Chief Executive of Rialto, is here to participate as well.

We have recently been together and completed our year-end review and our 2013 look ahead with our regional and division presidents, and we'll share with you some of our insights. I’ll begin this morning with some remarks on the overall state of the housing market. Jon and Rick will provide further color on our homebuilding operations. Jeff will update the Rialto segment, and Bruce will provide some detail on our Financial Services segment, as well as some more color on our overall numbers. As always, after that we'll open up to questions, and we request that during our Q&A time period that each person limit themselves to one question and one related follow-up. So with that, let me begin.

2012 was a turnaround year that confirmed that we had been -- what we had been seeing and communicating for several quarters, and that is that we are in fact in the early stages of the housing recovery. The recovery began in micro markets across the country, and it's continued to spread to larger pockets. In the second half of this year, recovery had taken hold across the country and has readily been seen in spite of generally negative economic data. While the current, more positive economic data still lags behind what we continue to see in the field, it, along with information from reliable economists, have instilled a new level of consumer confidence in the housing market.

While there have been and still are economic and political uncertainties ahead, we feel that this housing recovery is fundamentally based and driven by a long-term demographic need for housing. 2012, therefore, we believe, is just the beginning of the recovery as single-family starts come off their lows at just under 600,000 compared to the 50-year household formation average of 1.25 million households per year. Recent years' low housing starts and household formations have created a large pent-up demand of homebuyers who started reentering the housing market in 2012 and are likely to continue to do so into 2013 and beyond.

As this incremental pent-up demand unwinds, homebuilders are gaining pricing power. And after years of home prices falling, in 2012 the trend turned positive, initially stabilizing and then allowing for price increases across the country. Prior to this reversal, the fear of purchasing a home and losing equity kept many would-be purchasers sidelined in spite of historically low interest rates and fully loaded monthly ownership costs being low. With the added pressure of price increases, on-the-fence consumers have generally begun to come to the market to take advantage of low home prices and low interest rates.

Further fueling pricing power has been the record low levels of both new and existing home inventories as the staff inventory has been absorbed. New single-family homes for sale in November were up slightly from their all-time record low of 142,000 homes to 151,000. While existing single-family home inventory continued to decline through 2012.

Additional drivers for homeownership have been the continual increases in rental rates, which, on average, increased about 4% this year as vacancy levels reached their lowest levels in over a decade at 4.5%. It's estimated that there was slightly more than 200,000 multi-family units started in 2012, which is well below the long-term average of 340,000 per year. Across the country, homeownership monthly payments are more favorable versus rental rates. With the difference greater than it's been since the early 1970s, rental rates are projected to continue their upward trajectory due to a general lack of supply.

While rents continue to increase, the cost for monthly homeownership remains at very low levels. Impacts from rising home price increases had been largely offset by decreasing interest rates, which reached a low of 3.35% in December. If consumers are able to obtain a mortgage, they are doing so and in turn, saving money on their monthly expenses. The highly conservative mortgage market, however, is still restricted to many consumers. But with further regulatory clarity, as we've seen in recent weeks, the mortgage market should continue to open up at its margins.

In our fourth quarter, new orders were up 32% over last year, and our backlog was up 87% and the highest level it's been in 5 years. Gross margins improved to an industry-leading level of 23.5%, a 410-basis-oint increase over last year, and operating margins increased 660 basis points to 12.2%. Margins continue to benefit from our recent land acquisitions, higher home prices, lower incentives and operating leverage from greater absorption per community and more sales overall.

Our average selling price for the fourth quarter was $261,000, a 7% increase over last year. Our homebuilding operations have been improving due to a strong operating strategy complemented by an excellent management execution.

Our Financial Services segment had another strong quarter, with operating earnings of $33.2 million compared to $9.1 million last year. Our mortgage company captured some 78% of Lennar homebuyers within the markets in which it operates. UAMC has also benefited from a robust -- from the robust refinancing market. Lennar home mortgages should continue to grow alongside of our expanding homebuilding business and more than replace refinancing earnings as they begin to taper off.

On the Rialto side of our business, 2012 was a year of many milestones. Rialto closed out its first investment fund, the PPIP program, which garnered an overall 25% rate of return. In the spring, Rialto issued $132 million securitized loan inside of fund -- our first real estate fund, and that money went back into the fund to be reinvested. Additionally, our first Rialto Real Estate Fund was fully called within 6 months following its final close, and total investments in that fund are around $1.1 billion, including commitment leveraged, reinvestment of returns and co-investments.

We now have excellent visibility and firmly believe that returns for Fund 1 will well exceed expectations. The success of our first fund enabled Rialto to announce a few weeks ago the first close of Fund 2 in the amount of $260 million, with Lennar investing $100 million.

Financially, Rialto continues to contribute to our bottom line every quarter, contributing $4.6 million of operating profit in the fourth quarter and $26 million for fiscal year 2012. And as we go forward, Rialto should remain a solid earnings contributor and will create substantial long-term value for our shareholders.

Along with Rialto, 2 other long-term, value-creation initiatives have come to maturity. First, we've been incubating a multi-family rental business strategy that Rick will discuss shortly. We've assembled an all-star rental community development team and are poised to become a major participant in this market. We've also matured our FivePoint land company, which Jon will discuss shortly. FivePoint was initiated during the downturn to manage the restructuring of Newhall Land and Farming. FivePoint has now become the preeminent manager of large, complex, master-planned communities in the Western United States and will benefit substantially from the recovering market. Both of these initiatives, while not short-term earnings producers for 2013, will provide significant long-term value for our shareholders over the coming years.

In conclusion, let me say that after 7 years of navigating an unprecedented market downturn, we finally saw stabilization and recovery in 2012. As I reflect on where we've come from and where we're going, I'm optimistic that through -- that though there will be political and economic headline risks, the drivers of our business are fundamentally sound. As the housing market continues its overall trajectory back to normal, it will provide stimulus to the overall economy through job creation, as well as building consumer long-term wealth, which for generations has been a benefit of homeownership.

Today, Lennar stands alone with 5 distinct yet complementary operating platforms positioned to capitalize on a recovering real estate market. Our homebuilding machine is fully charged and continues to gain market share. It is well positioned and extremely well managed and will continue to be our primary driver of current earnings. Homebuilding is supported and enhanced by our Financial Services segment, which will grow in step with the homebuilder and continue to develop its third-party operations to enhance its bottom line.

Rialto continues to expand its franchise and invest in high-yielding alternative assets while supporting the homebuilder with access to off-market homesites. Our growing multi-family platform provides an additional long-term and complementary growth opportunity for the company and inserts Lennar's name in the -- into the homes of thousands of prospective homebuyers prior to their first home purchase.

And finally, FivePoint, with its large, long-term California land assets, simply couldn't be better positioned to reap the benefits of an appreciating land-constrained housing market. I am confident of Lennar's position in today's marketplace and rest assured that our growth trajectory is supported by a strong balance sheet with an exceptional group of people who'll be able to navigate through the challenges and toward the opportunities of 2013.

And with that, let me turn it over to Rick.

Richard Beckwitt

Thanks, Stuart. As in prior quarters, I'm going to talk about our land acquisition activities and then discuss our new apartment operations. We are really pleased with our operating results this quarter. We exceeded expectations across the board, benefiting from extremely well-purchased land assets.

During the fourth quarter, we continued our land acquisition program. This quarter, we purchased approximately 5,500 homesites for $242 million, and we spent $79 million on land development. Combined, our land acquisition and land development spend was up about 47% over the prior year period. In addition, we signed contracts to acquire approximately 2,750 homesites. From a geographic standpoint, approximately 45% of our land spend in the fourth quarter was located in the West, 26% in Florida, 9% in Texas, 8% in the mid-Atlantic, 6% in the Pacific Northwest, with the remaining 6% spread throughout our other markets.

As in prior quarters, money was invested geographically in the markets we saw the best opportunities. In Q4, we invested heavily in California and Las Vegas. We also have continued to invest aggressively in extremely high-margin opportunities in Florida and Texas, 2 of our strongest markets.

While the land market has heated up, we have found no shortage of great land opportunities. We continue to source land outside of the competitive bid environment with the help of Rialto and deep-rooted relationships with local land sellers. At November 30, 2012, we owned and controlled approximately 128,000 homesites and had 459 active communities. While we had guided to a slightly higher year-end community count last quarter, we sold out early in a few communities due to the faster-than-projected sales pace and some new community openings into the first quarter. In any case, we still anticipate ending the year with approximately 550 active communities, with the majority of these new communities coming online in the second half of the year.

On a year-over-year basis, our inventory at the end of the fourth quarter increased about $1 billion to approximately $4.7 billion, and this excludes inventory not owned, consolidated inventory not owned. During the fourth quarter, approximately 54% of our deliveries came from communities purchased or put on a contract during the last 4 years. And the gross margin on those closings was about 200 basis points higher than the company average.

Now I'd like to discuss our multi-family operation. Many of you, who follow the company, know that we've been nurturing a multi-family rental business for some time now. We entered this business following almost a decade of no new apartment supply because we saw significant pent-up demand and favorable long-term fundamentals. Despite a market rebound in the for-sale housing market, demand for rentals has accelerated, while supply remains extremely constrained. As demand for new sale housing continues to increase from historically low levels, rental demand has continued to grow, fueled by expanding household formations, credit- and down-payment-challenged new homebuyers and a steadily improving employment picture.

As a result, we believe that our core homebuilding business and our new rental segment are very complementary and that both should flourish in this recovering market. Multi-family segment began operations in early 2011 and was initially focused on maximizing the value of our underperforming single-family land assets by converting them to rental developments. During 2011, we expanded the scope of this operation to include acquiring new multi-family land assets and seized an opportunity to build an apartment business in a vibrant and growing rental market, while our core homebuilding business was recovering.

Today, our multi-family operation has a national footprint, with offices in Atlanta, Charlotte, Chicago, Dallas, Denver, Miami, Orange County, San Francisco and Seattle. We have an outstanding team of seasoned apartment development professionals for leveraging the entire Lennar organization to access development opportunities and harness the company's overall purchasing power to become a low-cost producer of Class A apartments in the multi-family space.

In 2012, we commenced construction on our 2 developments. We partnered with the Prudential Real Estate Investors for the development of a $32-million, 264-unit community in Johns Creek, Georgia, just northeast of Atlanta. Johns Creek is a highly amenitized Class A suburban infill community. The 3-story garden product is located in North Fulton County adjacent to Technology Park, an extremely low-vacancy market. We also partnered with The Carlyle Group for the development of a $36-million, 316-unit community in Jacksonville, Florida. This 4-story suburban infill community is ideally situated less than 50 yards from the campuses of 2 major employers. We expect to deliver our first phase of apartments in each of these communities by the end of the second quarter.

In addition to these communities, we have a geographically diversified development pipeline that exceeds $1 billion and over 6,500 apartments. In 2013, we plan to start construction on approximately 3,000 apartments, with total development costs of approximately $560 million. The capitalization structure for our new multi-family partnerships is approximately 30% equity and 70% debt. Lennar will invest up to 25% of the required equity, with the remaining equity contributed by third-party institutional sources. The debt is non-recourse, project-related construction financing provided by regional and national banks. From an overall capital perspective, Lennar will typically invest approximately 7.5% of the total development cost of each community. At November 30, 2012, we had approximately $30 million invested in this new business, and we see that increasing to $100 million by the end of fiscal 2013.

Consistent with our homebuilding business, our underwriting has been extremely conservative. Our underwriting assumes today's rents and targets an unlevered yield on cost of at least 125 to 150 basis points over prevailing cap rates for class A apartments. Depending on the specific deal structure and the economics, our expected returns, assuming a sale 1 year after stabilizations, should yield an IRR to Lennar's equity investment of between 25% and 45% and a cash multiple greater than 2x. While we anticipate merchant building and selling some of these apartment developments once they are stabilized, our long-term goal is to build a portfolio of high-quality, class A, income-producing properties across the country. With the benefit of Lennar's purchasing power and excellent access to unique land opportunities from both Lennar and Rialto, we feel we are extremely well positioned to become a leader in the apartment development business and create significant shareholder value.

Now I'd like to turn it over to Jon.

Jonathan M. Jaffe

Thank you, Rick. And good morning. In the fourth quarter, our sales pace continued at a healthy 3 sales per community per month even as we entered the traditionally slower part of the year, and so far, we have seen continued sales momentum through December into the first part of January. Our increased sales activity has allowed us to focus on improving our pricing power. Our year-over-year average sales price increased by $18,000 or 7% to $261,000. About 40% of that improvement came from a reduction in sales incentives by 320 basis points from 12.2% to 9%. Our ability to improve our sales prices, net of incentives, has enabled us to cover the increases in labor and material costs that are occurring and grow our gross margins by 410 basis points from the fourth quarter of 2011. We believe we will continue to improve our net sales price and be able to offset ongoing cost pressures.

For the full year of 2013, we expect our average gross margin to be between 23% to 24% compared to 22.7% achieved in 2012. Let me give you some color as to what we saw with respect to construction cost increases. Together, labor and material costs are up $0.64 per square foot year-over-year. This equates to about $1,600 per home.

First, I will discuss the labor component of that, which represents about 40% of construction costs. Labor remains under pressure, as housing starts accelerate and hiring by trades is slow to gain momentum. Many trades remain cautious about hiring, as they wait to see that the housing recovery is fully established. We're seeing the greatest pressure and therefore cost increases with framing and drywall labor.

Construction Materials also continue to experience upward price pressure. As starts have increased, demand for products is outpacing the ramp-up in production capabilities by manufacturers, as they're cautious to commit the capital to reopen closed plants. As housing starts continue to rise, we expect manufacturers will add back capacity. The material categories that have increased the most over the last year are lumber, drywall, concrete, cabinet and insulation. At Lennar, we maintain an intense focus on analyzing field construction variances and value engineering.

[Audio Gap]

area to note is that cycle time has lengthened on average by 10 days as compared to last year, and it ranges from no change in some markets to 25 days in markets that are more labor constrained such as Phoenix, parts of Texas and parts of Florida. This increased cycle time, combined with a larger number of early stage sales and backlogs, will result in a backlog conversion ratio of about 75% in our first quarter. We then expect the ratio to be about 90% for the balance of the year.

I'll wrap up my comments with a brief discussion on the activities of FivePoint Communities venture in California. Their business model is to create extraordinary value by obtaining development rights for large mixed-use projects and land-constrained markets. This team manages the 12,000-acre Newhall Ranch community in Los Angeles that will ultimately have 27,000 homes and apartments and 13 million square feet of commercial uses. The first 2 maps totaling 5,500 homesites and 2.2 million square feet of commercial uses are in the final stages of completing the entitlement [ph] process and will be brought to market in the next 2 years.

In Irvine, California, located in the heart of Orange County, is the former El Toro Marine base. This master plan of over 2,500 acres will be home to the development of the Great Park, which is larger than New York's Central Park. In 2012, 5,000 homesites and 1.2 million square feet of commercial uses were approved. FivePoint has also filed an upzoning application for an additional 5,800 homesites and 4 million square feet of commercial uses. Land development has commenced on the first phase of 726 homesites where Lennar and 7 other builders will grand open 10 villages this summer.

[Audio Gap]

Park, all located in the city of San Francisco. These committees will total over 20,000 residences in almost 5 million square feet of commercial uses when completed. All 3 are fully entitled, and land development has commenced at Hunters Point. Located in 3 of the best markets in California, Los Angeles, Irvine and San Francisco, the development of these communities totaling over 55,000 homes and apartments and over 20 million square feet of commercial uses will produce significant earnings for Lennar and its partners in the coming years.

Thank you, and I'd now like to turn it over to Jeff.

Jeffrey P. Krasnoff

Thanks, Jon, and good morning, everyone. Rick and Stuart have already discussed Rialto's role in the homebuilding story; and as usual, Bruce will cover more of the numerical details behind our financial results as part of his comments.

The bulk of our contribution for the quarter and the year has been coming from our growing investment management business, where we invest both our capital and that of third parties in funds and other vehicles. We participate in our share of the income from our investments in these vehicles, as well as the fees and carry interest we receive related to managing those investments.

Our first investment vehicle was the public-private investment fund in partnership with the U.S. Department of Treasury and AllianceBernstein. We originally helped to raise the private equity, which was then matched with government equity and advantageous financing, providing our team with approximately $4.5 billion to invest in and manage a large portfolio of mortgage-backed securities.

During the fourth quarter, we finalized our last sales of the underlying securities in our fund and made our final distributions to the partners, including us. On average, we had $61 million of our equity invested in the fund, and we've now brought back all of that investment, as well as profits and fees, totaling $112 million while generating a 25% internal rate of return for the company, as Stuart mentioned earlier.

The Rialto Real Estate Fund was the first fund on our own, for which we raised $700 million of private equity, including $75 million from us. All of our distressed and high-yield investment opportunities since late 2010 were made through this vehicle. We've now invested, as Stuart mentioned, approximately $1 billion of equity in the fund, which includes all of the original commitments, plus another $300 million of capital we were able to recycle earlier than anticipated from asset resolutions, principal and interest payments, property income, and financings. We've been able to invest in almost 60 different transactions amounting to about $2.7 billion of assets based on unpaid principal balance for less than $0.40 on the dollar. Activities here helped to contribute over $10 million to the company during the quarter from our share of the fund's underlying earnings, including our fees and reimbursements.

Overall, our actual performance has continued to exceed our original underwriting. At the end of September, the net asset value for the fund represented a 26% internal rate of return for investors. In addition, if we continue on this path on performance, we would expect to exceed the return hurdles set for our investors, which means that over time, carried interest would import back to Rialto as the manager of the fund. And none of that potential value is represented in our earnings today.

And now that our first fund has reached full investment, as Stuart mentioned, we expect to continue our program uninterrupted through our second fund, which, in late December, had its first closing of commitments of approximately $260 million, including $100 million from us.

Earnings from our early on balance sheet investments, including our structured transactions with the FDIC, continued to lag as a sluggish environment and broad government oversight and involvement have increased our cost to levels we had not anticipated and often in advance of the related revenues. It's worth noting that we made these investments before we refocused our investment strategies utilized our funds, acquiring assets directly from banks and including more assets with invoice cash flow.

We've remained very focused on our investments to create long-term value and bring cash back into the company to be recycled. This was an active quarter in cash flow generation from these transactions, and then to date, we have brought in well over $700 million of cash to reduce debt and to begin recycling capital back to the company. Our FDIC transactions have effectively less than $100 million left in net collections in order to fully repay the original $627 million of seller financing, after which we will begin getting our capital back. We expect to begin seeing this later this year and into next.

For the near term, we continue to see compelling opportunities for our core areas of expertise, including a clearing of distressed and subperforming assets from financial institutions; the growth of CMBS finance, where we have been a market leader; and providing the vital capital and managements repositioned and refinanced real estate assets.

Looking forward, our ability to add new diverse sources of business on our already existing management base of over 230 professionals and our growing fund program and investor base continues to move us further towards our initial plan of utilizing third-party capital to drive return on investment and to create a valuable investment-management platform. We're excited about the future and look forward to reporting to you on our progress.

And with that, I'm going to pass it over to Bruce

Bruce E. Gross

Thanks, Jeff, and good morning. Our net earnings for the fourth quarter were $0.56 per diluted share. This morning, there seemed to be a little confusion surrounding the tax line on our income statement.

This morning, there seems to be a little confusion surrounding the tax line on our income statement. Let me clarify that line. We had an $18.6 million net tax benefit for the quarter, which added $0.08 per diluted share. Our guidance last quarter was to assume no tax expense for the quarter. Excluding the impact from this tax benefit, our net earnings for the quarter were $0.48 per diluted share.

Let me provide a little more color to the results that you've heard this morning. The company's average sales price increased 7% year-over-year to $261,000. The average sales price by region is as follows: the East region was $245,000, which was up 11%; Southeast Florida was $264,000; that was down 1%, which was due to product mix changes; the Central region was $230,000, up 9%; Houston was $241,000, up 6%; the West region was $310,000, up 1%; and the Other region was $352,000, which was up 4%.

Our Financial Services business segment delivered another strong quarter, generating operating earnings of $33.2 million versus $9.1 million in the prior year. The fourth quarter improvement was helped by the strong refinance environment, leading to higher volumes, higher profit per transaction and strong operating leverage. Mortgage pretax income increased to $30.9 million from $9.1 million in the prior year.

We integrated the Eagle mortgage operations into our Universal American Mortgage platform over the past year, thereby leveraging both platforms and driving efficiencies. The consolidation of the back offices, secondary marketing and system enhancements resulted in a stronger platform to handle this year's increased volume. This quarter's mortgage originations increased by 52%, to $1.4 billion. Originations with non-Lennar homebuyers were 53% of the total originations, and that was primarily driven by the increase in the number of refinance transactions.

Our title company had a $2.9 million profit in Q4 and that compares with $1.5 million in the prior year. That was driven by a 31% increase in revenues. Adding a little more color to Rialto, the $4.6 million of earnings compares to $8 million in the prior year. Both amounts are net of noncontrolling interest. The composition of the $4.6 million of operating earnings this quarter by type of investment is as follows: The first Rialto Real Estate Fund contributed $4.2 million of earnings; the FDIC portfolios contributed $800,000; the non-FDIC wholly owned portfolios had a $3-million profit. And these amounts were reduced by $3.4 million of G&A expenses and other, which is net of management fees and reimbursements of $7.8 million.

As Jeff highlighted, we successfully completed our PPIP investment, and as a result, there is no income statement impact this quarter from the PPIP. This quarter, we reversed $45 million of the remaining deferred tax asset valuation allowance, leaving the $89 million in that valuation allowance going forward. If our earnings trend continues, we expect a majority of the remaining valuation allowance will reverse in 2013.

Our balance sheet liquidity improved in the fourth quarter, with $1.1 billion of cash and no outstanding borrowings under our $525-million 3-year unsecured revolving credit facility. We continued our balance sheet strategy of pushing out debt maturities while driving down our cost to capital as we raised $350 million of 4.75% 10-year senior notes during the fourth quarter. And during the quarter, we also received the ratings upgrade from Moody's from B1 to Ba3. Our net debt to total capital improved by 80 basis points, to 45.6% over the prior year, and our strong net earnings of $679 million in 2012 was the primary driver of a 27% increase to stockholders' equity, ending the year at $3.4 billion.

Turning to 2013, while it hasn't been customary to provide earnings guidance, I wanted to summarize what has been said on the call today and highlight a few additional items for next year. As Rick highlighted, we expect our ending active community count to be approximately 550 at the end of 2013, with a heavier concentration opening in the second half of 2013. Jon highlighted our backlog conversion ratio will be around 75% in the first quarter and then should be about 90% for the remainder of the year. He also highlighted that we continue to see a positive gross margin percentage trend increasing from an average of 22.7% for all of 2012 to between 23% and 24% as an average for 2013, with the typical seasonality throughout the year.

Financial Services has seasonality as well and that will continue in 2013. We do expect that the number of refinance transactions will slow down a bit in 2013, and the profit per transaction in the mortgage business is likely to moderate throughout the year.

As Jeff highlighted, Rialto is in a transitional year. PPIP was successfully completed in 2012, and Fund 2 will be ramping up throughout 2013, so Rialto profitability is expected to be more back-loaded in 2013. Excluding the impact from additional deferred tax asset valuation allowance reversals, we expect to have an effective tax rate going forward of approximately 39%. We are well positioned going into 2013 and look forward to another successful year.

With that, let me turn it over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is coming from Ivy Zelman, Zelman & Associates.

Ivy Lynne Zelman - Zelman & Associates, LLC

I wanted to drill in a little bit on -- Stuart, on your comments related to the mortgage market. I guess my first thought is, do you think that the stringent mortgage environment is an impediment to growth for 2013, '14 and beyond, and that it's necessary for that marginal buyer to have access to mortgage liquidity? Or can you continue to show robust growth despite the fact that there is credit stringency because there's enough pent-up demand or incremental buyers that have the credit? And then secondly, on the QM, you mentioned QM was a clarity relapse. Do you have any comments for us to understand the 3% capital as it relates to your mortgage company, please?

Stuart A. Miller

Yes. As to the first question, Ivy, I think that there is a lot of pent-up demand. That's what we're seeing in the field. There's a lot of sentiment that people want to find their way into homeownership and are willing to push through a much more conservative mortgage market in order to do that. Remembering that new homebuilding is coming off historic lows and trending upward, we think that there's a lot of room for growth even in a somewhat moderated environment. I think that the mortgage market does present itself as somewhat of a limiting factor. We do not see nor do we think it's healthy for the mortgage market to revert back to the liberal standards that we came from, but a reversion to normal, which will take some time, is likely as certainty is brought back to the rules surrounding the financial market. So given the fact that there's very, very strong demand, very compelling reasons to move from a rental world to a for-sale world given the low monthly payments, and given the fact that at the margins, the mortgage market is opening up a little bit at a time, we think that there's -- there are very healthy growth prospects as we look ahead to 2013. And, Bruce, why don't I give it to you for the second part?

Bruce E. Gross

Sure, let me comment on the QM definition that just came out this past week. So there's a year before this goes into place and it's been given a year to work through some of the clarifications that are included. So this clarification needs quite a bit of further clarification, so it's unclear at this point how that's going to work out. But right now, the 3%, we think, if you include the closing costs that we contribute to the buyer in the process, if that's not included in the 3%, then it's essentially a very minimal issue. So the clarification of how our contribution is included is important to figuring that out. We have a year to work through that, so certainly no impact of this year. And we think it's likely to be worked through and we're not expecting any major impact as we go into next year at this point.

Ivy Lynne Zelman - Zelman & Associates, LLC

No, that's a great answer. And I guess my follow-up question, Stuart, could you talk then about a lot of the, I guess, variables in the market that you're faced with and challenges? There's a lot of concern in the investment community about cost inflation, which you addressed, the labor shortages and certainly concern about the land inflation. It seems as if your greatest concern would more likely be about, at least from your company's perspective, is the continuation of replenishing loss as they get absorbed probably more quickly than you anticipated. Can you just give us sort of a ranking to the challenges and is that cost inflation, labor shortages, just a natural part of the cycle? And if not a concern to you, certainly, execution is everything? But I think it would help if you clarify to the investment community your thoughts on these issues that are the most pressing and yet challenging but not debilitating.

Stuart A. Miller

Well, okay. So look, I think that I said there's -- there are political and economic headwind risks out there. There's a big noise factor and some of these things can impact the market, especially consumer confidence. But I think overall, our view is that we're coming off of a very severe downturn. The fundamental reasons for recovery are really pretty solid and fundamental right now. We think, additionally, that consumer confidence is really on a recovery kind of ramp. And so I'm going to kind of take the macro picture out of the equation in terms of my biggest concerns right now just because I think that the more housing recovery -- recovers, the more jobs there are in the marketplace. The more jobs there are, the more confidence there is. And the more people are employed, the more likely they are to go out and buy a home. So to me, I kind of feel like the toughest part of the business is probably the part of the business where we are at our maximum strength and that is, in a recovering market, land becomes the biggest constraining factor. Across the market right now, it is the biggest constraining factor for builders. Driving community count and finding new locations is very difficult. I think we have the A team on the field, both between Rick, Jon and their respective leaders of the company and our Rialto complementary component. I think that the toughest risk factor, the land factor, is one that we have well covered, but I do think it's a risk out there as you look beyond 2013 into '14 and '15 as the market recovers. On the cost side of the equation, I think it's healthy and appropriate that costs start to go up in a recovering market and it actually portends better things for the economy. The fact that labor shortages are starting to present themselves and wages are starting to move up really says that the economy is on the mend, unemployment is likely to go down. And as unemployment goes down, confidence goes up. So we're going to see some cost pressure, but offsetting that cost pressure, we think, are increasing sale prices, which, if you look at the relationship in terms of percentages between cost and revenue, costs have to go up and up an awful lot before revenues don't cover. So I think that there's some risks out there. I think the macro is manageable. I think land is our area of expertise. And I think that the cost increases are actually healthy and will be offset by revenue.

Operator

The next question is coming from David Goldberg, UBS.

David Goldberg - UBS Investment Bank, Research Division

My first question has to do with the multifamily business, and I think you guys did a great job talking about the capital allocation and the kind of capital build and equity build you guys expect in '13. What I'm trying to get an idea about is, as you look toward the future and you look at the 5 different platforms, are they competitive for internal capital? And I want to get a little more color about the decision-making process as you think about allocating capital between the businesses, because it seems like the hurdles that you're kind of solving for aren't that dissimilar between the homebuilding business, Rialto, the multifamily business and then anything else.

Richard Beckwitt

Well, I guess, from an overall capital perspective, David, I would tell you that all capital competes within the company. We invest in the individuals and the assets that produce the highest returns. That's what we've done consistently throughout this recovery. We dedicated a certain amount of capital for each platform in order to grow those platforms and create value. And depending on how each one of those platforms is capitalized, because the multifamily operation includes a lot of third-party capital, we can grow a very sizable business quickly without using a lot of Lennar capital. So we do dedicate capital to each business. The returns have a tendency to be consistent amongst all the businesses, which is a good thing, and that gives us the luxury of investing in the best of the best.

Stuart A. Miller

Let me just add to that, David, that one of the advantages that the public companies have right now is access to capital that is very, very strong, in many ways unprecedented. It gives us a lot of opportunity to deploy capital and having various arms in which -- through which to do that is, we think, a real benefit. But keep in mind that whether it's the Rialto strategy or the apartment strategy or FivePoint, all 3 of these are primarily focused on third-party capital primarily, with a small portion of company capital invested at a sizable return in line with what we do on the homebuilding side. But we're building franchise value and ultimately long-term shareholder value in building these platforms and growing them forward. It's multiple avenues for investment, limited investment in some of these programs, with a strong opportunity for franchise value in the future.

David Goldberg - UBS Investment Bank, Research Division

Great. And then just as a quick follow-up, I kind of wanted to ask Ivy's question about labor in a different way. What I wanted to get an idea about was how you feel like your labor subcontractor force is capitalized. And do you think one of the reasons they're a little slow to react in terms of new hiring and expansion is because they're having trouble financing that expansion? And how does that affect you? And how can you guys help?

Stuart A. Miller

No, from what we've been able to see in the field, it does not seem to be that our subcontractor base is limited by their ability to capitalize their growth. We think that they're getting paid almost on a real-time basis as the competition for labor out there requires current payment. So that's not really the limiting factor. I think you have somewhat of a natural dislocation of the labor force through a downturn, where the labor force, especially in a protracted downturn, seeks and moves elsewhere and goes to other parts of the economy. Drawing that labor back is a function of job availability and wages starting to move up. That's happening in the field right now. And I think you're seeing a little bit of a timing issue that is going to work its way out.

Jonathan M. Jaffe

I would just add to that, David, that for the trade, they want to be cautious not to hire and then find that because of political noise and headline risk, the market is not as robust as it seems and then they've got to lay off again. So there's a lag time, as Stuart says, between when they'll actually feel comfortable in hiring and when we need them to be hiring.

Operator

The next question is coming from Stephen East, ISI Group.

Paul Przybylski - ISI Group Inc., Research Division

Actually, this is Paul Przybylski on for Stephen. I was wondering, with respect your cost increases, are you seeing those move up at a steady rate or are they accelerating? Or are we seeing any type of plateau? And then how does that relate to the increases in ASP that you're seeing?

Jonathan M. Jaffe

Well, it varies across the range of materials. It's not -- one answer doesn't fit all categories. So lumber, we're seeing lumber futures reach high levels, so that has accelerated. Concrete has accelerated. But other materials have plateaued. And I think that you're going to see a fluctuation as we look forward based on capacity to deliver those materials against the levels of increased starts.

Paul Przybylski - ISI Group Inc., Research Division

Okay. And then if I could sneak in one more. With your land purchasing right now, are you being able -- are you able to pencil deals closer to what we just did in 2012 or closer to your 2013 guidance?

Richard Beckwitt

Our underwriting assumptions haven't changed since we started buying land a couple of years back. We benefit because we're a little bit further advanced and further along the land continuum pipeline, so we're really investing today in deals for 2014, 2015. Don't be confused. We still are underwriting to extremely high margins and you can see it in the numbers.

Operator

The next question is coming from Michael Rehaut, JPMorgan Chase.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

First question, just on the gross margin guidance, 23% to 24%. Bruce, you mentioned some seasonality and just wondering if that would certainly then imply, if I'm just understanding that correctly, that you would expect year-over-year improvement perhaps to continue throughout the year, given the trends of home price appreciation and lowering of incentives outpacing cost inflation.

Bruce E. Gross

The answer is yes, we do expect year-over-year improvement in gross margin percentage and the seasonality, as we've seen last year, starting with lower gross margin in the first quarter and building up through the year.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Okay. Second question, on the Rialto earnings breakdown, it's been somewhat choppy in terms of the different line items and appreciate some of the clarity. And we've had PPIP closing out and it had a gain last quarter. FDIC had a loss last quarter, but part of that due to some impairments. How should we think about the FDIC, the $740 million of bank loans, the real estate in terms of trend lining throughout 2013? Should we expect gradual improvement? And also with -- as you get closer to fully defeasing the FDIC debt, would there be any type of more perhaps material improvement in those earnings? Or is that a non-factor from an accounting standpoint?

Stuart A. Miller

Let me say that Rialto continues to be a little bit choppy and a lot of that derives from the initial FDIC deal. We invested a lot of company capital in that deal with the -- with a higher expectation of return. We've talked about this in past quarters. Those levels and expectations have come down in large part because the resolution, the market for resolution of distressed loans just has been different than our past experience. And so what we're looking forward to with the FDIC program is a complete defeasance of the debt and then a return of that capital to be redeployed and at much more substantial returns. That's the negative side of Rialto. The positive side of Rialto is that every investment since that FDIC has built on that initial start-up investment and has been a success in terms of our underwriting standards which were recalibrated and the new investments coming in. So there's a little bit of an offset. There continues to be a little bit of choppiness in Rialto as we look ahead, as 2013 continues to be a transitional year. But Rialto is becoming a very substantial manager of third-party capital and investing that capital extremely well. And as we enter our Fund #2, we're expecting a lot of success and bottom line growth.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Appreciate it. Can I squeeze one more in on SG&A real quick?

Bruce E. Gross

Sure.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

You had an incremental variable rate on SG&A in 2012 of roughly little over 6%. How should we think about 2013 as you're growing your community count fairly substantially?

Bruce E. Gross

Sure. So again, as we're growing our community count substantially, there's a couple of things to think about. Number one, we're still selling at a sales pace that's well below normal. So this last quarter, we had 3 sales per community per month. When we get closer to 4 sales per community per month, then it will kind of flatten out. So there's more leverage that we will be seeing in the SG&A line as volumes increase and even though we're opening new communities. Additionally, the variable expenses, we did have some doubling up last year because we had different stock awards that, that compensation expense was flowing through in 2012 and some of those are no longer being expensed. So we don't expect on the corporate side the G&A to go up at the same level. We expect to get a lot more leverage on the corporate side.

Operator

The next question is coming from Stephen Kim of Barclays.

Stephen Kim - Barclays Capital, Research Division

I wanted to ask you a sort of a general question about your expansion into multifamily. You guys more than any other builder have really demonstrated an ability to sort of move into alternative streams of profitability and this seems like yet another opportunity, it seems like a good one. I guess, in helping us understand how large this opportunity could ultimately be -- I know you've laid out some general guidelines in terms of the next year or so, but thinking out more broadly than that, are there certain -- can you help us think what the limitations are for this business, if there are any that you foresee, in terms of it relative to your homebuilding platforms in all the various markets that you're in? For example, are there ways that you can easily express markets that you're in, in a homebuilding basis that you wouldn't be interested on a multifamily basis? Are there certain resources and the types of land acquisition opportunities that you see typically that are suitable for multifamily and where there are certain limitations? Or is this a business that you could scale pretty freely relative to your homebuilding operations?

Richard Beckwitt

Well, Steve, it's Rick. Clearly, we've got the footprint out there to grow a very sizable business. If you look at the major metropolitan areas that we are in, we can scale a business relatively quickly in those markets that will be sizable. You see that within a year, we had created about a $1-billion pipeline. I think that's just scratching the surface of what the opportunity is out there, especially as we leverage the mother ship and growing this through purchasing and synergies from an overall operating standpoint. If you'd step back and when you look at the basic fundamentals of a land buyer, we are -- we often, in the past, would sell the multifamily pieces, the commercial pieces for someone else to sort of ring the bell and make a lot of money on. And as we sat and looked at what we were doing in the land market in a recovering market, it didn't make sense to not maximize the skill set that we had in place. It's easier to build a multifamily complex than it is to actually build separate homes. So what we did is we structured an organization, we've surrounded ourselves with talent and we've been building this business and it will become very sizable.

Stuart A. Miller

Let me just add to that and say that, look, one of the drivers that we had in moving forward with multifamily is, first of all, historically, multifamily has been 2, 3, 350,000 starts a year and that's consistent over a long period of time. There is a consistent demand for multifamily and we think we have a distinct advantage. We're already looking for residential land. Often, it's an appendage of a broader or bigger property that we're already purchasing. We have the Rialto eyes also out there for these types of properties. And we have the complementary construction business that's already in place, where we can leverage efficiencies over a broader community. But our general thesis relative to entering multifamily is given the severe downturn in the residential markets over the past years, given the limited supply of rental that is out there, the recovery of the housing market would be moderated by a much more conservative mortgage market going forward, which means there will consistently be a large group of people who simply can't buy a home and won't buy a home and are looking for rentals. And then all of the major markets where we build for-sale homes, there's going to be a sizable demand for rental at the same time side by side. For-sale housing will continue to recover. It'll be moderated by a sluggish or conservatized mortgage market, and rental will remain strong as well.

Stephen Kim - Barclays Capital, Research Division

Great. Well, that's a pretty exciting opportunity and I wish you the best of luck with that. I wanted to ask you a question, if I could switch back to the more pedestrian homebuilding side of your business, and it's related to the gross margin guidance. I just wanted to clarify the guidance you've given there. For while it's strong and you guys have seen a nice recovery in gross margins already, I was -- I'm thinking that perhaps some are wondering if it could have been stronger, your guidance could have been stronger. And I'm curious, you mentioned that there is an upward trajectory in prices, but I assume that your gross margin does not assume or embed in it an increase beyond what we've seen thus far in prices. I'm curious as to whether or not that's true and also whether or not you are assuming any increases in costs next year for the units that you're going to be building next year, perhaps costs that were negotiated in a bit of a -- at the end of last year or being renegotiated now that will be at a higher level in 2013, for example, that's embedded in your assumption as well.

Bruce E. Gross

So this is Bruce. To answer your question, Steve, that is correct. We're not assuming higher average sales price increases than what we've seen, number one. And number two, we are seeing some higher costs embedded in our guidance, but our guidance is really saying that we believe we will more than offset the cost increases that we're seeing in the business right now, between sales prices going up some, sales incentives coming down, bringing in some of these new communities that we keep talking about that are at a higher gross margin than the company average, partially offset by some cost increases that we're expecting through 2013.

Operator

The next question is coming from Bob Wetenhall, RBC.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

I just wanted to follow up, I think, on Rick's comments. It sounds like Johns Creek and the Jacksonville build-out are ramping up pretty quickly. When should we start to anticipate seeing any meaningful or material impact for the multifamily business on the P&L? And what's the trajectory? You used the word in the press release, incubate? What point do you feel the business really has scale that really matters to the Lennar story?

Richard Beckwitt

Well, from an earnings standpoint, Bob, given the fact that these things take 1 year to 1.5 years to 2 years to build, you've got to lease them up and stabilize them. So you're looking at probably 3 years out before there can be a pretty decent stream of income if we're going to sell the properties. In a perfect world, what we'd do is we'd have a development operation where we'd sell the buildings, and then we would also be a piece of the operating company on the other side through a fund ownership structure where we can accumulate a huge portfolio of income-producing properties that would benefit the company on the long-term basis. So it was an earnings drag for us in 2012. It's not going to produce earnings in 2013, but in '14 and '15, you'll start to see some contribution from this new business.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

And just staying with the multifamily, there's some pretty established operators and there are, like, Equity Residential and Avalon Bay, but at the same time, it sounds like you feel it's not too crowded an environment. Is this just really a kind of bold call on the recovery of the multifamily segment, as well as single family?

Richard Beckwitt

Well, as Stuart and I highlighted, the growth opportunity in multifamily is pretty big today, especially given the fact that the business has been shut down from a new product standpoint over the last decade. We see significant opportunities out there. You got to keep in mind that a lot of people that play in the multifamily space are not developers, they're actually going out and acquiring existing assets out there and paying the cap rate. We do feel that we have expertise in development. It's not any different to build a condo building than it is to build a 3-story garden. And we're going to capture that development profit and, ultimately, build a portfolio of assets.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Good. It sounds like a nice complement to your core homebuilding.

Operator

The next question is coming from Nishu Sood of Deutsche Bank.

Rob Hansen - Deutsche Bank AG, Research Division

This is Rob Hansen on for Nishu. I just wanted to ask you a question about you've got the 5 different businesses and, obviously, Financial Services is most complementary to homebuilding, but then you've got the other 3, and I think you've kind of indicated in the past that maybe you would be willing to spin off Rialto in the right environment at some point in the future. Now with FivePoint and the multifamily, would you ever be willing to do that? And what kind of hurdles would you be looking for where you would come to that decision?

Stuart A. Miller

Well, just putting things in proper perspective, I mean, Financial Services is directly related to homebuilding, but FivePoint, likewise, is a direct offshoot of our land and homebuilding operations as well, so it's extremely complementary in much the same way. The apartment component is really a side-by-side relationship as well, and Rialto is a little bit more removed from our primary business. With that said, I think that the reason we highlight these other 3 businesses today is not by way of mapping out earnings for 2013 and '14, but by way of highlighting that within the company, these are the things that we've been working on that we think create long-term value and potentially might be -- we've created them with the optionality of keeping them within the company to the extent that they enhance the bottom line going forward or spinning them out as self-sustained entities as we did with LNR in the 1990s. We've highlighted that we might do that with Rialto. And these other companies also can be stand-alones at some point. It's maximum optionality for the creation of shareholder value over the long term.

Rob Hansen - Deutsche Bank AG, Research Division

Okay. And then on the multifamily business, is a lot of the source of the land going to be coming from Rialto? And then also, have you looked at -- you kind of thrown out the longer-term multifamily start summaries. Have you looked at what kind of a normalized market share you could have of that?

Stuart A. Miller

We haven't looked at market share, what a normalized market share would look like. In terms of where the land is coming from and will come from, some of the land is coming from our own, wholly owned assets that are being repurposed for apartment and brought to market sooner than they might otherwise be in a for-sale environment. But by and large, we've used that as a springboard to develop a first-class management team. And most of the apartment rental communities or the land for those communities is being sought for exactly that purpose and is being purchased in the open market. So there are new opportunities. They might be side by side with for-sale or with something that Rialto is doing. They're not coming from Rialto.

Operator

The next question is coming from Jade Rahmani, KBW.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Regarding Rialto, does the increased interest in REO properties from institutional investors, particularly single-family rentals, create any opportunities such as through bulk portfolio sales, through asset management of REO, assets for portfolio holders or through the market's increased demand for REO properties more broadly?

Jeffrey P. Krasnoff

It's Jeff. I'd say the demand really has -- has really impacted, it's more on the sales side. We've been an active seller of homes that we've taken back, but not directly from consumers but from developers that -- where we may have bought the distressed debt. I think, to date, we've probably sold about 1,000 homes. So there's pretty good demand out there for it. In terms of looking at bulk opportunities, we've also been looking at some of that. And we've been looking at some of the other opportunities that are out there that you've mentioned as we have not been a large entrant in the buying of single-family homes for rental.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Land sales picked up in the quarter and were at the highest levels since 2008. Is this onetime in nature or seasonal or would you expect a further pickup going forward? And specifically, could you look to monetize any of the internally developed land on purchases made during the market decline through an increase in land sales?

Jeffrey P. Krasnoff

Yes, Jade, land sales continue to vary from quarter-to-quarter. So when this quarter's results do indicate that, it's going to continue at that trajectory. It will be a little bit lumpy from quarter-to-quarter.

Operator

And the last question is coming from Adam Rudiger, Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

I wanted to go back to gross margins, but I wanted to talk about a little bit longer term, if possible. One, I was wondering if -- what the impact from prior impairments was on gross margins right now. And then I wanted to, Bruce, ask you what you think -- whenever you think we're going to be back in a new normal kind of environment, of normal starts levels, what you think gross -- Lennar's gross margins could be? And the reason I ask is because I think there's a lot of optimism built into your company and into the industry. And some of the -- my competitors' estimates and some of the new estimates I've talked about with investors seem to suggest that gross margins in the next upswing are going to exceed prior cycles and that history is not going to repeat itself and you're going to have better gross margins. So I was just curious what you thought of that and if that's the way you think things are going to play out.

Bruce E. Gross

So with respect to the prior impairments going through our gross margin, it's not a number that we've tracked, but what I would say is that, that number isn't -- I won't expect it's very significant as we've been growing our volume and we had over, I think, it's 54% of our deliveries were coming from new communities at this time. So that's not a very large number that's flowing through the P&L, is what I would expect. And going forward, as far as gross margins, we think there are a number of opportunities for the gross margins to continue to grow. And obviously, we've talked about some of them today. Average sales prices are still well below where they were at the peak. And with affordability being very high, there's room for average sales prices to grow, especially as inventories, as constrained as it is, and the rent versus buy equation is in favor of buying. We have more new communities coming online. The gross margin in the new communities is still over about 200 basis points above the company average. And we have sales incentives that are continuing to have the ability to continue to decline. And then you have costs that will go up, but that's a smaller percentage of the equation because your costs are less than 1/2 of the sale price. So going forward, there's room for it to go up, but I think we just want to moderate it. We want to see the results first before people get too carried away with the gross margin in their models.

Stuart A. Miller

Right. Let me just say that we are looking ahead with a conservative view. As we look at the market in general, as we look at land constraint, as we look at the recalibrated cost structure that we and others have in place, and as we recognize that home prices are not skyrocketing and shooting up, but they are reverting to normal, which means, in part, the base price of homes is going up. And in comparable part, we are eliminating an incentive structure that has been rather dramatic in order to sell homes during a downturn and that is working its way out. There's real opportunity for margins to go up. We're going to cautiously look ahead, seeing our margins go up in orderly progression. But I think that there is opportunity to the upside in terms of margin growth. And I think that's a large part of why you're seeing a lot of people who look at the housing market today look ahead to the next couple of years and say, with land shortage and with a reversion to normal in pricing and elimination of incentives, there's a lot of opportunity for margin growth.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

I think that's exactly why I'm asking the question because -- and I just -- I guess, what do you think the -- I mean, a lot of the things you talk about makes sense, but those things have to happen, all of your competitors have to act that same way, so do you think there's a -- is there -- traditionally, the industry liked to say 18% to 20% was the gross margin and that's what everybody said. And do you think there's an industry kind of cap where incentives might be where they are and you can reduce them, but somebody's going to then lower them to take some share? So how much of your optimism, recognizing you're still being conservative, but how much of that might be tempered by the industry's structure? And how do those 2 levers counteract each other?

Stuart A. Miller

Well, I think we have seen that in prior recoveries. As I look back, we've certainly seen that as the market recovers, people do sometimes moderate the margin they can get with the one that they trade off for volume. What -- but the governor here is the scarcity of land. You just can't replace the most important commodity as readily as we've seen in the past. And therefore, when you look at the competitive landscape, if someone's got a good land position, they'd better harvest the best margin that they can or that land is going to dissipate and they're not going to be able to replace it. That's the governor that's out there and why we think that margins have more opportunity to the upside than risk to the downside. All right, listen, thanks, everyone, for joining us on our fourth quarter update, and we look forward to reporting through 2013.

Operator

This will conclude today's conference. All parties may disconnect at this time.

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