Lennar Corporation: How the Fed Is Cooling Inflation In the Housing Market

Plenty of evidence exists that the Federal Reserve’s fight against inflation is working. Home builder Lennar Corporation (LEN) recently provided a vivid example of how the Fed’s rate hikes have forced the housing market to correct and push back against inflationary pressures. Deflationary forces are now at work in the system.

In last week’s Q4 earnings conference call, Lennar described an important chain of events that are underway. The company has been proactive in getting ahead of slowing demand and rising rates by purposely reducing margins to accommodate price reductions and incentives on a community-by-community basis. (The following housing markets are Lennar’s most problematic: Orlando, Pensacola, Northern Alabama, Austin, Phoenix, Utah, Reno, and Portland). In turn, Lennar is using its size and market dominance to force concessions from its supply chain. For example:

“We have very strong relationships with our trade partners. We have demonstrated to them that we have taken the first step by lowering sales prices to drive sales, and they understand this and understand the dynamic of labor availability as overall starts slow and they’re working closely with us to lower their prices…As with our trade partners, our land partners or sellers understand that we are maintaining volume and increasing market share while taking the first hit to our margin. They will need to work together and participate or we’ll need to move on.”

Lennar was even more direct in describing its advantage when inferring that the supply chain needs the work that Lennar can provide by keeping sales volumes flowing:

“…you really can’t underestimate the leverage that we get in working with our trade partners as things slow down across the board. People are looking for work. If we’re going to be the ones out there to do — starting homes, we’re going to get cost concessions, bringing cost concessions from our trade partners, from our land partners, and we’re just going to continue”

The industry-wide slowdown in housing starts has “sped up the availability of labor and materials for Lennar.” As a result, the company can use its dominant market position to extract lower costs out of the supply chain. Scarcity in the supply chain is easing and inflationary pressures are easing. Smaller builders are likely suffering the most from this change in dynamics.

Interestingly, LEN jumped 3.8% to a 10-month closing high in response to what was a surprisingly bullish earnings report considering the market environment. This buying was particularly impressive given the post-Fed sell-off underway in the stock market. It looked like another win for the seasonally strong period for home builder stocks. However, since then, gravity has slowly exacted its toll as interest rates have started to climb again. That post-earnings celebration is completely reversed now. The chart below marks earnings with a dashed vertical line labelled “E” in the bottom axis.

Epilogue

An irony awaits the economy on the other side of this housing reality check. With builders slowing down starts in parallel with housing demand postponed by punishing mortgage rates, an economic recovery will deliver a rush that will expose new market dysfunctions. Home prices could quickly turn around as eager buyers once again scramble for limited inventory. The major builders will continue to move slowly in adding supply to the market. The intense rationalization of the housing market will keep “normalization” out of reach in the most attractive housing markets.

In the meantime, waning inflationary pressures should at least benefit more participants than runaway inflation.

Be careful out there!

Full disclosure: no position

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