Lennar Corporation (LEN) Q2 2013 Earnings Report, Transcript and Summary

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

Good morning. 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 assurance 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 affect future results and may 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 in this morning's press release and our SEC filings, including those 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.

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

Okay, very good. Thank you, and good morning, everyone. Thanks for joining us for our second quarter 2013 update. We're very pleased to share our results to you this morning. We are here in our Southern California office, as we're here to host our Board of Directors meeting, and to have our board spend some time with our California management team and to see some of our product out here as well. In the context of our board meeting, let me take this opportunity to welcome our newest board member, Teri McClure. Teri brings a tremendous amount of background and experience to our board, as she is General Counsel for UPS, and you can read more about Teri's experience and history in the press release that we put out this morning. Now this morning, I'm joined by Bruce Gross, our Chief Financial Officer; Dave Collins, who you've just heard from, who's our Controller; and Diane Bessette, our Vice President and Treasurer. Additionally, Rick Beckwitt, our President; Jon Jaffe, our Chief Operating Officer; and Jeff Krasnoff, Chief Executive Officer of Rialto, are here as well for our Q&A session. I'd like to begin this morning with some brief overview remarks on the overall state of the housing market recovery in the context of today's volatile market conditions, and then briefly overview our operations. Bruce, then, is going to, as usual, provide greater detail on our overall numbers, as well as some further comments on our Financial Services segment. And then as always, we'll open up for Q&A. As we have in the past, we request that during Q&A, each person limit themselves to one question and just one related follow-up. So let me begin. And to begin, let me state the obvious. Interest rates have moved higher and mortgage rates have moved from their unprecedented low point towards more normalized levels. And while this movement is not a surprise, given the improvement in economic conditions and in the housing market in general, it seems that the timing has caught the investor community off-guard and has shaken investor confidence in the overall housing recovery. Our view, though, is that the housing recovery is still very much intact and that the fundamentals of that recovery remain solid. The overriding driver of recovery in the housing market remains the underproduction of both single and multifamily product throughout the economic downturn and up to and including this year. Over the past 5 years of housing production, we've built an average of under 700,000 single and multifamily homes total per year, with an average obsolescence rate of approximately 300,000 per year. This compares to a need for new dwelling units per year of between 1.2 million and 1.5 million. This year, a significantly stronger year of building activity, we will produce approximately 950,000 single and multifamily dwellings, and again, will underserve the country's needs. We have more than absorbed the overbuilding of the early to mid-2000s, and have been underproducing for a protracted period of time. This shortfall will have to be made up, and the builders of both multi and single-family products have been pushing to increase production. The increase in production has been slow and difficult because of 2 factors. First, there's a shortage of entitled and developed land to build on and land prices have been moving higher. Secondly, the increased production has created labor shortages in many major markets. We hear of the labor shortage not just from the builders in the field, but also from the manufacturers and distributors that serve the industry. While these shortages add to the cost to build in the short term, they also fuel the longer-term prospects for housing, as employment drives confidence and the wage increases that lure workers off the sofa and back into the field to meet demand also enable more families to afford to purchase or rent. While production continues to lag the need, we are experiencing supply shortages against a growing demand. While some have argued that increased demand is being driven by low interest rates, we believe that it's being driven by a generally improving economy, driving household formation and a decoupling of households under one roof. New families are seeking to find independent shelter. Where attractive financing is available and obtainable, households seek for-sale product. But in the absence of a for-sale option, they seek rentals. But that just increases demand for rentals and drives up the rental rates, making for-sale monthly payments even more attractive. The bottom line is that there are too few dwellings for a growing population and for normalized household formation. Inventories are low for both new and existing homes, as well as for rentals. As demand increases, there are fewer homes or apartments to purchase or rent, and prices are being driven higher, as you can see in today's Case-Shiller results and today's new home sales beat. Distressed homes are being absorbed by the investor community and repurposed as rentals. In the short term, these rentals are helping to fill the void of the short supply of rentals for growing demand. The relationship between rental rates and for-sale monthly payments has favored homeownership for some time now. Even with interest rates edging upward to more normalized levels, the monthly payment math continues to push families to find a way to purchase, in order to lower their monthly payment, to increase their disposable income, and to stabilize their living expenses without annual repricing. And interest rates, though modestly higher, are still at historically low levels. Customer perception at this point remains that today's low interest rate still presents a unique opportunity to lock in a very low cost of capital, and this opportunity might not be available forever. At current interest rates, affordability remains at historically very high levels. Even with more significant movement in both interest rate and pricing, homes remain affordable by all measures, and will continue to remain attractive relative to rental options as well. Finally, while demand for homes has been constrained by an overly-restrictive mortgage market, which has limited access to homeownership with highly conservative underwriting criteria, the landscape is improving, as lenders are beginning to reconsider their credit underwriting overlays and open the doors for more -- to more approvals. While this process has been and continues to be slow to mature, we've come a long way since last year at this time, and we expect to see further easing of credit standards to normalized levels and further extension of credit to the market. As we've seen in the past week, there have been, and still are, economic and political uncertainties ahead that will affect and bring questions to the future of housing. We continue to feel that this housing recovery is fundamentally based and driven by a long-term demographic need for dwelling units. We believe we're still in the beginning stages of a recovery that will be sustained for several more years. Now turning to Lennar. Lennar has been, and continues to be, very well-positioned for recovery in housing. This is reflected in our second quarter 2013 results and in our positioning for the future. In our second quarter, new orders were up 27% over last year, and our dollar value of backlog is up over 76%, to its highest level in 5 years. Gross margins improved year-over-year to an industry-leading 24.1%, a 160-basis-point increase over last year. And operating margins increased 410 basis points to 13.3%, reflecting the powerful operating leverage in our absorption rate growth. For the full year 2013, we expect our average gross margin to continue to improve throughout the year. Margins continue to benefit from our aggressive land acquisition strategy, as well as higher home prices, lower incentives and operating leverage from greater absorption per community of approximately 4 per month now, which is a significant improvement over last year, and then, of course, from more sales as well. During the quarter, we continued our aggressive land acquisition program and closed on approximately 8,700 homesites for $450 million, and that land had basically been contracted between 1 and 2 years prior to its closing. Additionally, we spent approximately $122 million on bringing land to developed status, ready for production. Combined, our land acquisition and land spend is up about 100% year-over-year. Our average selling price for the second quarter was $282,500, a 13% increase over last year, which covered the increases in labor and material costs, and increased -- which increased approximately 8% over the prior year. Our Homebuilding operations have been improving due to a strong operating strategy, complemented by an excellent management team and management execution. Additionally, we opened 93 new communities and closed out 83 communities during the quarter, to end at 9 -- 492 active communities, a 12% year-over-year increase. Today, we are fortunate to have the land in-hand to meet our projected deliveries through 2014 and as a result, we're pursuing land opportunities for 2015 and beyond. This is an enviable position in today's market, and is a position that was earned through our very strategic land acquisition program that began back in 2009. Complementing our Homebuilding operations, our Financial Services segment had another strong quarter, with operating earnings of $29 million compared to $18 million last year. Our mortgage company captured some 79% of Lennar homebuyers within the markets in which it operates. Mortgage operations have also benefited from a robust refinancing market, which of course, is now starting to subside. Lennar home mortgages should continue to grow alongside our expanding Homebuilding business, as well as serve non-Lennar purchasers in a growing number of markets. While our Homebuilding and Financial Services divisions are the primary drivers of near-term revenues and earnings, our 3 additional operating divisions are all maturing to be excellent longer-term value-creation platforms for the company. Rialto continues to grow as a blue-chip capital investment management company and commercial real estate capital provider. While current earnings have slowed as we have shifted from balance sheet investment to a fund investment model, the prospects for future consistent earnings continue to improve. We have now invested or committed almost $1 billion of equity through Fund 1, and we are now harvesting those investments. Performance for the fund is already well ahead of original projections, and we started distributing capital back to investors and have returned almost 1/2 of the original investment. In addition, if we continue on our current performance path, we expect we will exceed the return hurdles set for our investors, which means that the carried interest to Rialto, as the manager of the fund, will exceed our expectations, and none of that potential value is reflected in our current earnings picture. Finally, in December, Fund #2 had its first closing of commitments of approximately $260 million, including $100 million from us. And in the second quarter, we closed an additional $260 million to bring the total in Fund 2 to $520 million closed, which is about halfway to our total goal. And we have already started investing that capital as well. Although the shorter-term earnings have slowed, we have morphed to a private equity program and our Rialto program is maturing. We are very excited about the long-term prospects for value creation from this program. Lennar multifamily, our apartment division, has now commenced construction on 5 apartment communities nationwide, totaling approximately 1,500 apartments and $225 million in development. And it's moving forward with a growing pipeline. We expect that rental will continue to thrive alongside the for-sale market, as many will not be able to access the for-sale market and rentals will meet their housing needs. Even with the step-up in apartment production nationally, additional product will be needed to meet the demand to fill the shortfall from prior years. Finally, FivePoint Communities is quickly moving to bring developed land in premium locations to the market, to fill the growing demand for well-located, approved and developed homesites. This quarter, we saw the first earnings contribution from this division, which will continue to contribute as additional land becomes entitled and developed over the next years. In conclusion, while we are aware of the concerns that are being reflected in current market volatility, it is our belief that the market remains positioned to continue to recover, and that our company is exceptionally well-positioned to benefit. The housing market is healing and recovery is accelerating as we produce shelter that is needed for a growing population and a return to more normal levels of household formation. As the housing market continues its overall trajectory back to normal, it is providing stimulus to the overall economy through job creation and building long-term consumer wealth, which, for generations, has been the benefit of homeownership. Lennar's Homebuilding machine is extremely well-positioned and continues to gain market share. We have excellent land positions in all of our major markets, while the land market, overall, is very constrained, and we have an excellent management team that will continue to be our primary driver of current earnings. Homebuilding, of course, is supported and enhanced by our Financial Services division, 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 investments, while supporting the homebuilder with access to off-market homesites. Our growing multifamily platform will continue to provide an additional long-term complementary growth opportunity for the company. And FivePoint, with its large long-term California land assets, could not be better positioned to reap the benefits of an appreciating land-constrained housing market. Although there continue to be political and economic headline risks, the primary drivers of our business are fundamentally sound. I am confident of Lennar's position today in the marketplace, and rest assured that our future growth is supported by a strong balance sheet with an exceptional group of leaders, who will be able to navigate through the challenges and towards the opportunities that lie ahead. With that, let me turn over to Bruce.

Thank you, Stuart, and good morning. Our net earnings for the second quarter were $0.61 per diluted share. If we excluded the reversal of the deferred tax valuation allowance in both years, and normalized the tax rate at 39%, the EPS comparison per diluted share would be $0.43 for the quarter versus $0.15 in the prior year. Revenues from home sales increased 58% in the second quarter, driven by a 39% increase in deliveries and a 13% year-over-year increase in ASP to $283,000. The average sales price by region is as follows: East region, $263,000, up 14%; Southeast Florida, $273,000, up 3%; Central, $257,000, up 12%; Houston, $253,000, up 10%; West Region, $321,000, up 5%; Other, $399,000, up 25%. The gross margins from our new communities purchased after 2008 continued to outperform the company average gross margin during the quarter, and they represented approximately 59% of the company's deliveries in Q2. Sales incentives were $20,200 per home delivered during the quarter, or 6.7% of home sales revenue. The sales incentives improved by 400 basis points or $9,600 per home delivered versus the prior year. The gross margin percentage for the quarter was highest in the East, Southeast Florida and West regions. Selling, general and administrative expenses, as a percentage of revenues from home sales, improved 230 basis points to 10.9%. And this is the incremental operating leverage that we've been discussing, primarily as our volume, and particularly, our absorption per community has been increasing. Again, our absorption per community this quarter was 4 sales per community per month. That's an increase over last year's 3.5 per community per month, and 2.9 in the first quarter of this year. This was the lowest SG&A percentage, as a percent of home sales, in the last 7 years. During the quarter, Stuart mentioned the El Toro joint venture sold their first homesites to homebuilders, including Lennar. Our 25% interest in the joint venture resulted in a $13 million profit on our joint venture line. Lennar purchased 3 of these communities that were sold by the venture, and the profit relating to the communities purchased by Lennar are deferred and recognized in our gross margin at the time that Lennar delivers the homes, which we expect to start in fiscal 2014. Turning to Financial Services. The second quarter improvement was again helped by the strong refinance environment, leading to higher volumes and higher profit per transaction. The mortgage pretax income increased to $26.1 million from $17.2 million in the prior year. This quarter's mortgage originations increased by 45% to $1.4 billion. Originations with non-Lennar homebuyers were 51% of the total originations this quarter. And again, that was helped out by the increase in the number of refinance transactions. Our title company had a good quarter as well. They had a $3.7 million profit during the quarter compared with $1.4 million in the prior year. Our Rialto business segment generated operating earnings totaling $2.8 million, compared to $4.3 million in the prior year. Both amounts are net of noncontrolling interest. The composition of Rialto's $2.8 million of operating earnings by type of investment is as follows: the Rialto real estate funds contributed $4.4 million of earnings; the FDIC and wholly-owned bank portfolios contributed a net of $4.5 million of earnings; and these amounts were reduced by $6.1 million of G&A and other, which is net of management fees and reimbursements of $9 million. The prior year amount included $2.7 million of earnings from PPIP, which was successfully completed in the prior year. At quarter end, the FDIC debt net of cash available in the defeasance [ph] account and in Rialto's cash account was down to $48 million. We expect this debt to be paid off around year end, and then there will be more significant cash flow generated back to the parent. During the quarter, we reversed approximately $41 million of the remaining tax asset reserve, all of which pertains to state taxes. This was the remaining reserve we expected to reverse this year, and going forward, we expect an effective rate of 39%. Turning to the balance sheet. Our balance sheet liquidity remained strong in the quarter, at $728 million of cash and no outstanding borrowings under our unsecured credit facility. In June, this facility was increased to $950 million, and the maturity extended to June of 2017. During the quarter, we issued an additional $50 million to our $525 million of 4.750% notes due 2022. And in the last 4 quarters, we have now issued a total of $1.2 billion of long-term senior notes, with an average coupon of 4.6%. I wanted to summarize what was said on this call and highlight a few items, additionally, for the remainder of 2013. Number one, we have noted an increase in our cycle time and have generated a high percentage of pre-sales during the spring selling season, and as a result, we expect our backlog conversion ratio to be between 75% and 80% for the third quarter. Although the backlog conversion is declining in the third quarter, we are well-positioned with our backlog and expect to deliver between 18,250 and 18,500 homes for all of 2013. As Stuart highlighted, our gross margin is increasing throughout the year. And with the strength of our backlog, it gives us confidence to increase our gross margin guidance to approximately 24.25% for Q3 and 24.75% for Q4. For a couple of quarters, we have highlighted that we expect the number of refinanced transactions will slow as we progress through the year, and the profit per transaction in our mortgage business is likely to moderate a little bit. Additionally, we are required to book profit on our mortgage originations at the time that we lock the loan. As a result, the profit for Financial Services is higher in the spring selling season, and we expect that profit in Financial Services will be sequentially lower, both in Q3 and Q4. As highlighted on the call, Rialto is in a transitional year, and we expect Rialto's profitability to continue to be backloaded to the fourth quarter of 2013. With that, let me open it up for questions.

[Operator Instructions] Our first question comes from Ivy Zelman of Zelman & Associates. Alan Ratner - Zelman & Associates, LLC: It's actually Alan on for Ivy. The first question I had just relates to kind of your stock performance year-to-date, which has underperformed despite, obviously, the very strong performance in your Homebuilding business. And we've heard from some clients just general concerns or questions about your expansion into some of the other ancillary businesses, such as apartments and obviously, the Rialto business, which the profitability has declined here a little bit. I was hoping you might be able to just put the rising rates -- put some perspective behind that on the impact on those ancillary pieces of your business, and obviously, in Rialto specifically, given the high-yield investments there, if you would expect to see any impact on future profitability from higher rates?

Wow. That's a lot of questions in one, Alan. But let me see if I can attack that. First of all, as it relates to stock performance, as a management team, we're highly focused on operational performance in the company, and the investor community is going to have to interpret things as they might. We, of course, have pretty much gotten out ahead of the rest of the market in terms of land acquisition and -- okay, so let me just continue. So we've gotten out ahead in terms of land acquisition and margin enhancement, and we've had pretty strong margin growth early on in the recovery cycle. So we've enjoyed, I think, a pretty good program relative to our position within the industry and our stock price as well. Perhaps that subsides it [ph] a little bit. I'm not really sure and, of course, interest rates have kind of altered the landscape for the entire industry, at least over the short term. As it relates to our fundamental business, we've said consistently, our primary driver is and continues to be our Homebuilding operation. We are extremely well-positioned from a land standpoint. We're well-positioned in terms of margin generation, and our management team really is hitting on all cylinders. With that said, our ancillary businesses are really well-positioned for future growth and for future contribution. Frankly, I have not been more excited than I am today about the prospects for Rialto, and as well, the prospects for our multifamily, even given the increase in interest rate that we've seen and the changing environment. Rialto has morphed from an on-balance sheet to a private equity model. In doing so, you're seeing fewer earnings flow through to the bottom line right now. That will change over time as our press starts to be brought into earnings in the future. But as it relates to our Fund 1 performance, it has been nothing short of exceptional, and Fund 2, monies are already starting to be invested. We are providing capital for commercial real estate financings and other positions within capital stack [ph] . We think that this is business is going to continue to grow, and is going to be a very exciting part of our story going forward. As far as the rental apartment properties division is concerned, we have a growing pipeline, growing from $1.5 billion to $2 billion in properties that are going to be coming online. As I noted in my opening comments, we have 5 properties under construction. And I think in the context of a market that is short on dwelling units overall, people are going to be looking to purchase because the monthly payment is lower, if you're able to purchase. But if not, there's a growing demand for rentals, and we think that rental rates are going to continue to be pushed up higher. So even with interest rates going up, we feel pretty comfortable about the rental community development as well.

I guess the only thing I'd add, too, is all the time we've been expensing startup costs associated with these businesses and our pretax income has doubled on a year-over-year basis, and our margins are up on a year-over-year basis. So I think we've been a good steward of the capital. Ivy Lynne Zelman - Zelman & Associates, LLC: Okay, Rick, I appreciate that, and sorry I jumped on late. You guys couldn't hear me, I was muted. But I think that Stuart, as the most senior tenured leader of the industry, I think people would really appreciate maybe a little bit more specifics on your view of the backup in rates. I know you said that -- you commented that we have a lot of room to go. But what rate starts to get you nervous? And I recognize you can't really think about rates in isolation, so can you give us your more elaborate sort of expectations on what really starts to make a difference from the consumers' affordability?

Well, Ivy, the first thing that I'd say is that rates have been at historically low levels. They're reverting, and maybe they're actually starting a movement, or maybe it will ebb and flow a little bit. But they're going to ultimately revert to more normalized levels. Now, but you can't look at the interest rate in isolation. We have to be looking at interest rate in the context in which they're moving, which means an improving economy, an improving employment picture. We are seeing labor shortages across the country, not just for the homebuilders and people in the field, but for manufacturers and distributors. We're hearing from all of those people that, not only are there labor shortages, but wages are moving up in order to get people off the sofa and back into the field. And this portends good things for demand for housing, both on the for-sale and the rental side. Interest rates that are moving higher in the context of economic improvement, employment improvement, at the same time, really reflects a healthy economy and a healthy movement. And for housing, in general, has historically meant that housing is going to thrive, as more people are able to afford to buy or to rent and to match-up with the supply that is available. And of course, right now, we're looking at a supply shortage, so that means that even in the context of rising rates and a better economy, we're likely to see price increases and rental increases as well.

Our next question is from Jade Rahmani of KBW. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: I wanted to ask on Homebuilding SG&A. I think last quarter, you provided some sequential comparisons and expectations for the rest of the year. I think given the step function down this quarter, would you be comfortable providing any expectations for the rest of this year on that line item?

Sure, Jade. This is Bruce. I think as you look at the next quarter, I would expect a similar type of SG&A percentage as we had this quarter, and a little bit more leverage as we go into the fourth quarter, as we expect to have more deliveries in Q4. So we'll see what that percentage is. But figure flat next quarter, and a little bit of improvement going into Q4. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Regarding Rialto, is there a way we can think about the value of the carried interest benefit that you could receive? And have your -- are your comments meant to suggest that this could be a 4Q event? Or would that be next year?

I think I'd be looking to next year, and we haven't given guidance on the magnitude of the carried interest. But we are becoming more enthusiastic about our prospects in all of our fund investing. And I think that we'll have to ask for you to be patient, until we have better clarity to bring to the market. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. And finally, the pick up or the -- reportedly Rialto has begun conduit operations or is in talks regarding that, I think you alluded to that in your commentary. Should we expect all of those lending programs to flow through the private equity funds rather than through the wholly-owned subsidiary earnings?

A lot of the capital activities will be wholly-owned. So it will be -- some of that will be split between the private equity and the on-balance sheet. But the operations that are kind of the natural evolution of that business, the conduit activities, the origination side, is generally on-balance sheet. The purchase of securities and special servicing is going to flow more through the private equity, so it's kind of split.

Our next question is from Stephen Kim of Barclays.

I had a couple of questions for you. One, I guess the question we're getting a lot from investors relates to the impact of rising interest rates on your business and obviously, you've done a good job here of addressing the fact that you really haven't seen that yet. Implicitly, it would seem that if you have not -- if you're not anticipating seeing, let's say, a 100 basis-point rise that we've almost absorbed, affecting demand, implicitly what you're saying is that the buyers who have been buying over the last year have not been maximizing their purchase -- purchasing power and therefore, are able to absorb somewhat higher rates, and still make a decision to buy, essentially, the same unit and the same price that they would have bought, let's say, 6 months ago or prior to the higher rates. My observation is that that's probably true because the lending standards are much more difficult right now, and so if you can actually get a mortgage, you're probably a solid-enough citizen with a solid-enough balance sheet that you're probably being relatively prudent. But I'd love to hear your particular view on whether or not your buyer, over the last 6 months, has been able to buy more than they have been buying and therefore, can tolerate a higher rate environment?

It's Rick. As we were coming out of the downturn and people were trying to get a sense of footing of where the economy was going, I think they didn't put everything they could into the home. They left a little bit on the table. They wanted to feel and see the economy improving. And we've seen, over the last 12 months, incremental changes in the type of spec level that we've been putting in our homes, given the fact that people have a little bit more appetite and purchasing power today than they had a year ago. But the other thing that sometimes gets skewed as you look at it from a lofty level, is that it's a different mix of buyers every day out there. And while we try to draw some comparisons on a trend line, it's real difficult to do because you have different groups of people, different products at any point in time that are for sale. But generally speaking, you're correct. There is increased purchasing power today, notwithstanding the fact that people had that muscle before.

Let me just add to that and say that there are a lot of different stories out there. I think in part, there has been a more conservative approach to using all of the buying power, as Rick just described. But additionally, this decoupling that is going on, people having been 2 generations under one roof during the downturn, and unwinding that has really enabled the generation that's moving out and finding its own new shelter to save money, to reposition their credit, and to be positioned to be able to purchase. That new entrant into the marketplace, or reentrant into the marketplace, as the case may be, is positioned to be able to make a lot of choices because they've saved some money and they've gotten their credit history in good position to be able to afford something. And the important thing right now, Steve, is the relationship between monthly payments in for-sale relative to monthly payments for rent, is really a driver and very compelling for people to find a way to afford as much as possible on the for-sale side.

Great. That's very helpful. My second question relates to your land spend activity. I think you did a good job of talking about the fact that you have a very strong land pipeline, and you've done a lot of things when times were bad, so that you don't really have to force anything now that times are getting better. I wanted to ask you, though, if you could help us understand what you would likely do differently in the near term, if, over the course of the next few months, God forbid, you did see something happening out in the field that was markedly worse, if the environment got markedly worse and you saw that in your selling communities, what would be the likely response in terms of your land spend activity? And I'm really trying to frame sort of how much of your land spend, that you've been doing and that you're expecting to do here over the remainder of the year, is for communities that you don't really need, in other words, like 2015, 2016 versus stuff that you actually kind of need to open in various markets in the next year or 2?

Well, Steve, It's Rick. As we've shared with you before, and Steve -- and Stuart highlighted on the call earlier, we've been way ahead here. I can tell you that while we're continuing to look for opportunities where we can feather in some things for the balance of 2013 if they fall in our lap, or early 2014, mid-2014, the lion's share of what we're looking for is 2015 and 2016. So with that said, a dramatic shift in the land environment, for us, would possibly be a good thing because it would create some turmoil out there in the market. From a general perspective, as we're looking at those type of opportunities, given the long runway that has to happen through entitlement or processing, and zoning, and those type of things, the values for those assets are still incredibly wholesale opportunities. So we probably wouldn't approach it in a different way, we might be a little bit more cautious. But given that's where we're looking, it wouldn't dramatically change what we're doing.

Are you buying those or are you optioning those kinds of properties out to 2015 and '16?

More often than not, what we're doing is we're working with the owner of the land, putting it under contract, giving them a small amount of earnest money, and helping them with the entitlement process by using our intellectual capital and expertise with the cities as currency.

Our next question is from Stephen East of ISI Group.

I don't know if this is for Stuart or Rick. But if you look at your markets, when you think about higher rates and lower affordability, what would be the top 2 or 3 markets that you think are most susceptible to having problems with the higher rates? And which markets do you think would be in the best shape?

I think, Stephen, pretty much across-the-board, affordability right now is at a place where the markets are going to -- look, we all recognize that there isn't a national housing market and each market is local and unique unto itself. But I think that affordability is in such a comfortable place right now, that when you ask about market susceptibility to interest rate movement, if you're in a range of moderate increases in interest rates, as we have seen, I think that all markets, pretty much across-the-board, are going to continue to be reasonably strong. So I wouldn't differentiate the markets unless you saw some kind of violent move in interest rates, which I'm just not projecting at this point.

Steve, it's Rick. I think it's more of a price-point issue as opposed to a market issue. I think when you get down into that sub-120 price point, if there is interest rate moves or confidence issues, then that business starts to get a little bit more difficult. Similarly, although most people would say that at the high-end of the market, those buyers don't necessarily need a mortgage, they're sophisticated buyers and they're getting one. And a movement in interest rate tends to, after time, affect the very high end. Given the fact that we're a first-time, move-up, middle-market, and some of our things are sort of second-time move-up, we think that we're pretty well insulated, to a large degree, from interest rate movements in the market.

Okay, that's helpful to me. And then if you look at El Toro, you had some nice community sales this quarter. As we look out over the next -- the rest of this year and '14, can you talk about -- give us some timelines so we can understand how we sort of forecast these businesses unwinding, not only El Toro, but some of your other parcels that you have in California?

Yes, Stephen, it's Jon. El Toro should see its next delivery homesites in 2014, about a year out from this first group that was just delivered. It would be a similar size, perhaps a little bit larger. What we just closed recently was about 725 homesites, and you should see an offering about once a year coming out of El Toro. In San Francisco, we just broke ground this month at Hunters Point, with product -- that product is being built within the venture, and you should see actual home deliveries from that in about 14 to 18 months.

All right. And just one last question, you talked about 59% of your delivery sort of from your new communities. Can you remind us what the differential was on gross margin? And whether you're still seeing that consistency, new versus old legacy land?

Sure, Steve, it's Bruce. We're still seeing approximately 200-basis-point increase in gross margins from the new communities we've purchased since 2008. Now the legacy communities are still doing well from a gross margin perspective, but the new communities are about 200 bps higher.

Our next question is from David Goldberg of UBS.

I wanted to follow-up actually on Stephen East's question and Rick's response, which I thought was a really interesting and good response on the buyer segment and price point, and how rates affect different buyer segments. And I'm going to ask a question, I don't know if it's answerable, but I'll give it my best shot, which is, when you think about that sub-120 price point, how important is that to the overall recovery of the housing market long-term when we think about past peaks and we think about getting margins -- excuse me, volumes back to starts, or new home sales back to where we were? And how important was that for Lennar in the last cycle? And kind of how important do you envision it as you go through this cycle?

Well, as far as how important it is for the industry, I think it's a function of 2 things. One is what employment growth is going to be, to a large degree, people buying that -- and whether it's sub-120, I used that as a number, it could be sub-110, that's probably a better number. There's people that buy. I think it has more of an impact on the resale market than on the new home market, because people will be not able to buy some of that product because there is less of a new construction market in that sub-120, 110 market. We're not really in that market except for a couple of divisions that offer some product like that. Bruce, you want -- or Stuart, talk about how this affected Lennar in the past cycles?

This is Jon. As Rick said, our -- primarily, what we're delivering is in the middle market. So as you're dealing with those people who are just trying to enter the market for the first time, that really didn't have a big impact on our business. And as you look at markets like California, which tend to do very well on the upswing, the big price movements, you're not in that price point anyway, even in the Central Valley. You're starting in the mid-2s to $300,000 price points.

And David, one other thing I'd say is this may be a different set of cards this time. And the reason I'd say that is there was such deferred purchasing. You're seeing an older group of first-time buyers coming into the market that may have double income associated with that. So I'm not sure you can truly draw parallels to what happened in the past, although I'm sure that someone can.

I just want to say, David, I think you might have gotten it right in the beginning when you said this question might not be answerable. I think at the end of the day, this is a new environment. We're going to have to wait and see how it unfolds in terms of -- every part of the market kind of interacts with other parts of the market. The move-up buyer historically has been selling a home to a first-time buyer in order to move up. Right now, the move-up buyer is coming out of mom and dad's home or a coupled environment. So we have a new evolution this time around. I think that one of the other defining components of this particular market recovery is the fact that we are dealing with a housing shortage overall, both on the rental side and on the single-family side. And so some that might be move-ups have to look at rentals, but rental rate is high, so instead they go for something that's smaller in nature and more affordable. It's going to be interesting to see how it evolves, and I don't think there's a clear answer.

Just one other quick question. Stuart, you mentioned in the prepared comments that you're seeing some easing on the credit standards side. Maybe you can talk about is that additional liquidity, more players, some of the more traditional, big correspondent lenders coming back to the market? Is it actually showing up in standards? Or is it just additional liquidity that you're seeing coming back?

I was watching CNBC as the CEO of LendingTree was talking yesterday, and I watched him struggle with some of the same questions. It's hard to put your finger on exactly where the loosening is taking place. I don't know if the customer is coming to the table better prepared with more down payment and more documentation, or if it's the lenders that are really opening the doors a little bit. But it's at the margins, and it's hard to identify exactly where the loosening is taking place, but it is. More people are getting approved, more people are finding their way to mortgage approval, and I think it's a trend that we're going to continue to see. Appraisals are clearly loosening up as part of the process as well. So I think the important thing to do is to look backwards a year or 1.5 years. And if you look backwards, you see we've come quite a long way in terms of people finding access to the mortgage markets. I think, as we look to next week and next month, it's hard to see where those incremental moves are going to come from. But I think a year from now, we're going to continue to see loosening and reversion to normal underwriting standards as markets, the financial markets, governmental markets, become more and more comfortable with an improving and recovering housing market overall. I think the overlays are just going to dissipate very -- at the margins.

One other thing I'd add to that, David, is one area that we are seeing some improvement is with the mortgage insurers. So there's a greater percentage of mortgage insurers coming back in, and that's allowing somebody that previously was going for a 20% down with a conventional mortgage, you're now seeing the ability to have lower down payments, and we see that that's likely to increase even further as we go forward.

Our next question is from Desi DiPierro of RBC.

On the labor and material side, you said it was up 8% in the quarter. In recent months, have you seen in a slowdown in the rate of increase, or even a decline in material prices, given lower lumber and OSB prices?

This is Jon. For example, lumber has just come down recently, but the way that the pricing works is that will affect our starts in this quarter and our deliveries into the fourth quarter and first quarter. So you'll see a trend up until those deliveries hit. Other products have been relatively flat. Of course, some commodities are down, like copper. So on one side, you have pressure from labor, that's pushing cost up. And then on the materials side, things tend to be plus or minus flat, with the exception of lumber, as I just mentioned, which came down for panels about 25% and dimensional lumber about 15%.

Got it. And then just looking at Financial Services, I know you said that operating income would be lower sequentially due to the seasonality. And so I also wanted to see if you, in addition to lower volumes, are you seeing a change in the spread on the mortgages that you're originating when you go to sell them as well, given the results [ph] ?

Sure. Spreads have been at high levels compared to historical norms. So we're expecting that, that will be the case as we go into the second half of this year. We haven't seen a lot of that yet, but the expectation should be that, that will be moderate as we go through the rest of 2013.

That is all the time we have for today. I would now like to turn the call back to Mr. Stuart for closing remarks.

Okay. Well listen, thanks, everyone, for joining us. As you can see, we're pretty enthusiastic about our positioning as it relates to the future, and we feel pretty strongly that the housing recovery is intact and likely to continue for some time to come. Thanks for joining us, and we'll report back at the end of next quarter.

This does conclude today's conference call. You may disconnect your phones at this time.