Saturday, July 5, 2008

Are Home Builder Write Downs Complete?

Last week we heard quite an optimistic statement from Stuart Miller, CEO of Lennar, a billion dollar (for now!) US home builder:

"...aggregate levels of impairment and losses are more the nature of clean up rather than reconciliation to unknown market conditions. We have done the heavy lifting on impairment and are now situated with stated assets that can and will produce improving margins when the rate of declining market pricing subsides. We are very confident that even with continued degradation of market conditions our stated asset base will not suffer nearly the levels of impairment we saw in 2007." (source:

This suggests Lennar has taken a big bath, and decided to write down inventory to the point where they actually make a "profit" on home sales. Nevertheless, it's impossible for Miller to know just how far the market will degrade. We saw here that home prices continue to fall. Obviously, they won't fall forever, but who knows whether they'll turn up next month or drop for more than two years. Miller is obviously making some sort of prediction that prices won't drop below a certain level, which is strange, considering some of the other comments on that same conference call:

"The housing market has continued to deteriorate throughout the first half of 2008 and as I noted in our press release this morning we expect this trend is going to continue for at least the remainder of the year."

"Demand patterns are inconsistent and erratic and we find that there is a constant and increasing flow of foreclosures that are maintaining downward pressure on prices and appraisals. In many markets it is apparent that the flow of foreclosed homes is expanding rather than subsiding."

"I am asked regularly as to whether or not we are at the bottom. I feel overall that we are not there yet."

Miller most likely knows more about Lennar than anybody, however, and as such, perhaps he has reliable indicators that suggest prices won't drop below a certain level. In the same call, he did note that inventory levels have been declining, and that construction costs are as much as 20% lower, allowing Lennar to produce homes more cheaply, with less homes coming online in the market (suggesting an increase in pricing power for builders).

While Miller may believe the bulk of write downs has already taken place, I believe it's irresponsible of him to state that "even with continued degradation of market conditions our stated asset base will not suffer nearly the levels of impairment we saw in 2007.", as this could dupe investors. Nobody knows how bad (or how good, to be fair) market conditions will be, so it is premature to make this call before prices have stabilized on the way down.

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