Lennar Turns REIT as Homebuilding Continues to Disappoint

| About: Lennar Corporation (LEN)

by David Urani

We noted last month after Lennar's fiscal 3Q earnings results that the housing market is about to get tough. We made light of the fact that a potential drop in prices leaves the Company in danger of tightened gross margins and another round of asset impairment charges. We still hold that thesis. We also noted that one aspect of Lennar's business, its Rialto investment arm, was one of the bright spots during the quarter. Lennar (NYSE:LEN) was back in the investment game again on Friday as it bought up $740 million worth of distressed real estate assets. That's a good way to take a little breather from homebuilding as it continues to be one of the worst sectors in the economy.

We have to commend Lennar for pursuing other avenues of earnings generation. As we said, Rialto was a highlight of its last quarter, posting $0.04 per share of its $0.16 total earnings. It also added $38.0 million of revenue to the $825.0 million total. The investments consisted of a 40% stake in 5,500 troubled FDIC mortgages which it paid $243 million for. Lennar was able to pick up those assets at a deep discount, giving them a relatively easy profit. The latest move on Friday includes a pickup of 397 more troubled mortgages with an unpaid balance of $529 million and 306 repossessed homes with a $211 million market value.

While this second pickup of $740 million of distressed assets is not as big as the first, which consisted of roughly $1.2 billion of assets, it is another rather sizeable addition to Lennar's balance sheet. At the end of its third quarter, Lennar had $3.8 billion of homebuilding inventory which was approximately flat from the previous quarter. Lennar also stated that it foresees more opportunities to buy cheap assets from the FDIC as repossessions gain steam. So, as you can see, Lennar is increasingly becoming an REIT as opposed to a homebuilder.

Lennar says this new pickup of assets will be accretive to fiscal 2011 earnings and we agree. However, as it stands, we still see Lennar's homebuilding operations losing profitability in the coming months. That being said, these distressed asset grabs could be just enough to tip Lennar into the black in 4Q and beyond.