Lennar Corp. may list its occupation as home builder, but its recently announced investment in government-possessed distressed real estate assets unveils what many would say is the company's true vocation, land wrangler.
It's not a new job for the company. During the last big downturn, Lennar found profit in working out distressed land deals through the Resolution Trust Co. Wednesday's announcement that Lennar subsidiary Rialto has formed a public-private partnership with the Federal Deposit Insurance Corp. (FDIC) to buy and then manage $3.05 billion in distressed real estate loans signals a return to those roots.
It comes as no real surprise since Lennar CEO Stuart Miller has been talking about doing just that since the downturn began. Lennar created Rialto and put Jeff Krasnoff, former CEO of the builder's LNR Property Corp., in charge more than two years ago.
The arrangement promises what appears to be a low-risk investment that should bring in revenue at a time when Lennar's home building business has shrunk to only 23% of market peak. Lennar delivered 11,478 houses in its 2009 fiscal year compared with 49,568 in 2006.
Here's how the deal is set up, according to information filed in an 8-K with the Securities and Exchange Commission.
Rialto is a sub-advisor to AllianceBernstein, a Public Private Investment Project team approved by the government to buy, manage, and monetize loans that the government has bought back from banks.
A limited liability company was created to hold 5,500 distressed residential and commercial real estate loans from 22 banks in receivership.
Those loans with balances of $3.05 billion are essentially bought for $0.40 on the dollar, $1.22 billion, with Lennar/Rialto contributing $243 million in equity, the FDIC contributing $365 million in equity, and the remaining $627 million coming from a no-interest, non-recourse seven-year loan from the FDIC. Lennar itself has $75 million in the deal, and the FDIC keeps 60% equity in the entity.
Rialto is charged with managing and monetizing the loans and will be paid management fees for its work. There are three basic ways the loans can be worked out:
--The borrower can pay off the loan at an amount less than what is owed, but more than the $0.40 on the dollar paid for the asset;
--The LLC could foreclose on the loan, taking back the assets and then selling to a builder/developer investor as is, or in bulk. Or it could hold the land until market conditions improve; or
--It could "value add" after foreclosing on the property by developing, redeveloping, and/or leasing, and then selling the property.
Lennar has reported that every $0.10 of value over the $0.40 purchase price creates about $122 million in profit.
The builder said it spent four months with more than 30 underwriters working with Lennar personnel and other third-party firms to explore the assets and their potential worth. Those results were then reviewed through a number of "roundtables" where each asset was presented by the underwriter to the broader Rialto team.
Of the residential properties, 25% are partially developed, 24% are dwellings, 10% is raw land, and 9% are finished home sites.
The commercial assets include retail, 8%; office/industrial, 7%; and other, 6%.
Analysts of Lennar have weighed in favorably on the deal, as did investors, who bid the stock up nearly 9% to $16.97 in heavy trading late in the Thursday session.
"LEN is using its expertise and capital to exploit distress and generate income," wrote CITI analyst Josh Levin.
In the short term, it will add between $10 million and $15 million of net income for the company in the second half of 2010 and $20 million to $30 million for 2011, said Levin.
The move also will give Lennar access to land it could use in its home building operations in the future, but Levin doesn't see that as the main reason for the investment. "Rather, we think LEN intends to generate most of the profits by monetizing the loan portfolio."
"Overall, given the accretion, non-recourse debt financing, and we believe strong level of due diligence and management expertise in place to manage this portfolio, we believe this transaction represents a positive for LEN and the beginning of a more aggressive use of its balance sheet," wrote J.P. Morgan analyst Michael Rehaut.