Earnings Call
Lennar Corp /New/ (LEN)
Earnings Call Transcript - LEN Q4 2022
Operator, Operator
Thank you, and good morning. Today’s conference call may include forward-looking statements, including 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 yesterday’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.
Operator, Operator
I would like to introduce your host, Mr. Stuart Miller, Executive Chairman. Sir, you may begin.
Stuart Miller, Executive Chairman
Thank you, and good morning, everyone. I appreciate you joining us today. I’m in Miami along with Rick Beckwitt, our co-CEO and co-President; Diane Bessette, our Chief Financial Officer; David Collins, our Controller and Vice President; and Bruce Gross, CEO of Lennar Financial Services. It's great to have Bruce with us again. Jon Jaffe, our co-CEO and President, is participating from California. As usual, I'll begin with a macro and strategic overview of the Company. I’ll be a bit more detailed than usual since there are strategic matters to discuss. After my remarks, Rick will review our markets, Jon will update us on supply chain, cycle times, and construction costs, and provide an overview on land. Diane will then present detailed financial highlights and we’ll provide estimates for the first quarter to assist in your modeling and projections. After that, we’ll take as many questions as possible, and I ask that you keep it to one question and a follow-up. Once again, the Lennar team has delivered excellent results for the fourth quarter and year-end 2022, enhancing our positioning for shifting market conditions. The fourth quarter saw a deterioration in market conditions due to a documented interest rate-driven slowdown in sales and pricing adjustments, combined with a stressed supply chain, high labor and material costs, and increased cycle times, leading to a complex environment as we wrapped up 2022. The rapid shift in interest rates has quickly impacted both affordability and consumer confidence, resulting in significant changes in market conditions and demand. Sales and prices have decreased substantially in both new and existing home markets, and stringent commercial underwriting has limited new-for-rent properties. We anticipate production for single-family and multifamily homes nationally to decline by 25% to 33% in 2023, worsening the housing supply shortage. This means production will drop from around 1.5 million homes annually to about 1 million. Rick will present further insights on market conditions shortly. Despite the rapid cooling of demand, we face challenges from a correcting yet disrupted supply chain, persistent high labor and material costs, and increased production times. Jon will elaborate on these points. On a positive note, we have very limited new home and existing home inventory, as homeowners retain low mortgage rates. The limited multifamily production, compounded by a decade-long housing production shortfall, puts the industry in a position of what we believe to be a relatively short duration correction with no significant inventory overhang. In addition, despite the impact of two hurricanes in Florida, our home building and financial services team has focused on executing the strategies we’ve discussed in earlier quarters, making efficient adjustments to our business model. We presented the Lennar strategy playbook previously, and those strategies, along with our successes and setbacks, are reflected in our results for the first quarter and year-end. First, we will continue to sell homes, adjust pricing to market conditions, and maintain reasonable volume. We utilized our proprietary dynamic pricing model to guide volume-based pricing, ensuring our sales align with current market conditions, balancing volume and sales to sustain steady production. This model allows margins to flex as conditions change, particularly with interest rates, potentially improving lagging margins during rate decreases. In the fourth quarter, we saw margins drop by 270 basis points to 25.3% before impairments as we implemented price reductions and incentives to navigate market volatility. Although our cancellation rate has increased to 26% from 12% last year, it is showing signs of improvement from a peak of 28% in October, and we expect it to normalize below 20% soon. Our strategy allowed us to maintain volume in a challenging environment — our sales were down 15% year-over-year, yet we managed to start over 68,000 homes in 2022, a modest 1% decrease year-over-year, giving us visibility for potentially flat deliveries in 2023. Despite pricing pressures, we are confident in achieving sales at favorable prices due to our investment in digital marketing, which has become increasingly vital. Our proprietary digital platform, built on Microsoft, offers insights that enhance our pricing execution. Our digital marketing team, led by Ori Klein, is doing remarkable work. Our second strategy involves collaborating with trade partners to align costs with current market conditions. Jon will provide more details on this shortly. Together, he and Rick are leading efforts to reconcile costs across our platform, focusing on our production and purchasing teams. Lennar has led in reducing margins while maintaining volume and market share during market corrections, and we expect our trade partners to join us in driving down costs. Our third strategy focuses on land and acquisitions, which we are reviewing carefully to minimize exposure to declining land values. We have halted poor land deals, reconsidered development expenditures, and are committed to protecting cash by only purchasing land with strong margins at today’s prices. Our fourth strategy targets managing SG&A operating costs to ensure strong net margins, even when gross margins are lower. While we’ve successfully reduced SG&A to new lows, further cuts will be necessary to maintain percentages as sales prices decline. In the fourth quarter, we maintained SG&A at 5.8%, and if we continue driving volume, we can manage cost increases effectively. The fifth strategy aims to maintain strict inventory controls, crucial for optimizing cash flow. Our fourth quarter results show careful management, reflected in our 14.4% debt to total capitalization and $4.6 billion cash position. It's worth noting the press has raised questions about the 5,000 homes sold to single-family for rent purchasers at significant discounts due to market conditions. We, like other builders, provide a listing of homes available for sale to these buyers. Over the past year, we have sold around 7% of our homes to single-family for rent purchasers, including Quarterra, and we expect that percentage to remain similar in 2023. Our net margins for these homes are comparable to those sold to primary buyers, with no unusual discounting. Our operational focus is on starts, sales, and closings, managed through regular meetings to balance these elements and maintain low inventory of unsold completed homes, currently around 900. Our land inventory is also closely monitored, with oversight from our corporate office. Although inventory increased due to supply chain delays, we expect this inefficiency to resolve over the next few quarters, translating into cash flow and reducing debt due in 2024. Our tight land and inventory controls have improved cash flow, resulting in a negative net debt to total capital ratio. The sixth strategy emphasizes prioritizing cash flow to protect our balance sheet. Reflecting on our fourth quarter results, we’ve accomplished this, and expect continued strong cash flow as we execute our strategies. Lastly, I must report a miss on the timeline for the spin-off of Quarterra, which will be postponed due to unfavorable market conditions. While I believe we have a strong public company ready to launch, we will hold off until conditions are favorable. In conclusion, despite challenging market conditions, I believe our homebuilding and financial services teams have demonstrated remarkable execution this past quarter. We ended the year with record revenues, profits, cash flow, balance sheet strength, and liquidity. We have a clear action plan moving into 2023, focusing on maintaining volume, managing inventories, and enhancing our balance sheet. We'll aim for first quarter closings between 12,000 and 13,500 homes, with a gross margin projected at around 21%. While this may be our lowest gross margin of the year, we expect to maintain flat delivery volume as we strive to increase market share and improve margins. As we move forward, we will remain resilient in the face of adversity and committed to our strategies. Before I conclude, I would like to acknowledge Jeff Roos, one of our Regional Presidents, who will be retiring after 27 years of service. Jeff has been a tremendous asset to Lennar, and I take pride in having worked alongside such a talented leader. His commitment to excellence and community betterment has been invaluable, and I'm confident that his legacy will continue with the capable talent he has nurtured. With that, let me hand it over to Rick.
Rick Beckwitt, Co-CEO and Co-President
Thanks, Stuart. As you can tell from Stuart’s opening comments, the overall housing market has been reacting to a significant increase in mortgage rates, which has impacted affordability and home buyer confidence. While we continue to have many strong markets, in our more challenging areas, we've had to adjust base sales prices, increase incentives, and provide mortgage rate buydowns to maintain or regain sales momentum. Our sales strategy has been to find the market clearing price for each of our homes on a community by community basis as quickly as possible, and price our homes accordingly. In many cases, we're solving to a monthly payment and not to a sales price. This requires a detailed understanding of community and product-specific pricing, financing programs, traffic trends, inventory levels, and buyer sentiments. During the fourth quarter, our new sales orders declined 15% from the prior year on a 4% lower year-over-year community count. Our year-end community count was lower than we projected at the beginning of the year as we walked away and renegotiated on many communities. Jon will walk you through this as he discusses our land strategy. While our cancellation rate and sales incentives increased sequentially from the third quarter, our sales orders and sales pace per community was relatively flat throughout the fourth quarter, as we successfully executed our pricing strategy in most of our markets. To maintain and regain sales momentum, our fourth quarter new sales order price declined 9.5% sequentially from our third quarter, with mix accounting for 250 basis points of the decline, and base price reductions and incentives accounting for 200 basis points and 500 basis points, respectively. The combination of adjusted pricing and rate buydowns have created a more stabilized environment. As we cleared out or closed many of our older contracts in our backlog, our backlog has reset to these new prices, admittedly at lower margins, and we're seeing more stability and a trend toward lower cancellation rates. To this point, our cancellation rate peaked in October, declined significantly in November, and we've seen a continued reduction thus far in December. We fundamentally believe that this price-to-market strategy reflects our balance sheet for its focus, where we can maintain starts and sales, generate cash flow, and keep our home building machine going. To this end, as Jon will discuss, by maintaining our starts pace, we've been able to get cost reductions from our trade partners, and significantly increase our market share as many of our competitors that either stopped or slowed starts altogether. I'd like to now give you an update on our markets across the country. They really fall into three categories: One, markets that are performing well; two, markets where we've adjusted pricing and incentives, found the market price, and have successfully regained sales momentum; and three, markets that may require some additional pricing adjustments to regain our targeted absorption pace. During the fourth quarter, and so far in December, we had eight markets that are performing well. These include Southwest Florida, Southeast Florida, Tampa, Palm Atlantic, New Jersey, Charlotte, Indianapolis, and San Diego. These markets are benefiting from extremely low inventory and many are benefiting from strong employment and strong local economies. While these markets continue to be strong, we've had to offer mortgage rate buydown programs and normalized incentives. Our category two markets, which reflect markets where we've made more significant adjustments and have successfully regained sales momentum, include 23 markets. These include Jacksonville, Ocala, Atlanta, Coastal Carolinas, Raleigh, Virginia, Maryland, the Philadelphia Metro Area, Chicago, Minnesota, Nashville, Dallas, Houston, San Antonio, Colorado, Tucson, Las Vegas, California Coastal, the Inland Empire, The Bay Area, Central Valley, Sacramento, Seattle, and Boise. While inventory is limited in each of these markets, we've had to offer more aggressive financing, base price reductions, and/or increased incentives to regain sales momentum. The size of the adjustments is varied on a community-by-community basis and has often been limited to specific homes each week. In some cases, to avoid cancellations, we've had to adjust pricing on our homes in backlog. We’re being very proactive with our pricing and not reactive. This has allowed us to sell homes and avoid building up finished inventory. We're outselling the competition, and as I said, increasing our market share. Our category three markets, which reflect the more significant softening and correction include eight markets. These include Orlando, Pensacola, Northern Alabama, Austin, Phoenix, Utah, Reno, and Portland. While the driver of the individual dynamics of these markets varies somewhat, traffic has slowed, buyers are taking more time to purchase, and many need to be convinced that now's the time to buy. There is fear that prices haven't hit bottom, which has led to elevated cancellations. In these markets, we're focusing on establishing pricing that generates new growth sales to offset the cancellations, and we have achieved that. This is required to work with our backlog to prevent cancellations. It also required a mix of base price adjustments, sales incentives, and mortgage buydown programs. While we've made progress in each of these areas, we still need to make some adjustments going forward. There's not a one size fits all solution. I'm confident, however, that we're making progress in each of these areas, and we're very fortunate to have limited completed unsold inventory, so we should be able to get these markets back on track in the first quarter. I hope this gives you a better picture of our markets across the country and what we're doing to keep our sales activity going. The markets are very fluid, and we're making proactive strategic decisions and adjustments every day. We are committed as a management team to address any future market changes. And as we've said in the past, we're going to keep our homebuilding machine going to maintain our starts and price our homes to market. This is our balance sheet first focus.
Jon Jaffe, Co-CEO and President
Thank you, Rick. Our well-executed strategy of pricing to market to maintain sales volume, as Stuart and Rick have detailed, set us up for the next part of our game plan, our construction strategies. Simply put, by continuing to sell homes and generate cash flow, we'll keep starting homes. Our construction playbook has three primary areas of focus: lowering construction costs, reducing cycle time, and achieving even-flow production. Properly executed, these strategies improve both gross and net margins, allowing us to profitably continue the cycle of finding the market to sell homes. Let me address each area. Reductions in construction costs have historically lagged the change in market conditions. While that is true this time, what is different is the speed of change in the market conditions has caused a sharp reduction in industry-wide starts, thus speeding up the availability of labor and materials for Lennar. This is very quickly turning the shortages of the last two years into excesses. Taking a look back at our fourth quarter, construction costs continue to increase as we guided on our last earnings call. Increases in both materials and labor resulted in a total direct construction cost increase of 6% and 16% sequentially and year-over-year, respectively. Moving forward, our process is a three-pronged approach of first, working with our trade partners to reduce the cost of labor materials; second, evaluating all specifications in the home; and third, an intense value engineering review. 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. Since the beginning of our third quarter, we have reduced contracted costs by approximately $14,000 per home, or $6.22 per square foot. And this amount will grow throughout our first and second quarters as reduced demand for labor and materials accelerates. These savings will start to flow through our results in the back half of the second quarter and will primarily be seen in closings for the second half of the year. What has been a steady increase in construction costs over the last few years will reverse course in our first quarter with a small reduction in cost per square foot compared to our fourth quarter. This is primarily driven by lower lumber costs from earlier in the year. This improvement is already baked into our backlog as these homes started in the last four to six months. Cycle time is the second area of focus for our construction strategy. We see meaningful improvement in this area as cycle time was flat sequentially for the quarter, despite the cumulative effect of supply chain disruptions experiencing the two hurricanes that impacted production in Florida and parts of the Carolinas. Importantly, we saw cycle time improvement during the quarter for the front end of construction, which measures the duration of time from trenching to insulation. This first part of the construction process is the first to see labor free up and came down an average of eight days during the last four weeks of our quarter as compared to the prior four weeks. As Stuart noted, bringing down our cycle time throughout the next few quarters will free up significant amounts of cash that are tied up in inventory, further strengthening our balance sheet. The third area of focus is even-flow production. Prior to the pandemic and its related supply chain disruptions, even-flow production was a core focus for us. It is a key pillar for being the builder of choice for the trades as it maximizes efficiencies for them. The steady pace and rhythm of starts through completions is absolutely critical and is only achieved with real-time communication between all parties. From Lennar’s offices and fields to manufacturers, to distributors, to trades, and then back to us, information such as projected start dates and day-by-day scheduling in the field is enabled with rigorously adhered to technology-driven tools and processes. Level construction flow of our homes drives field and G&A efficiencies for both the trades and Lennar, opening improved margins for both. As Stuart noted, this is an intense focus of both Rick and myself, along with our national, regional, and divisional purchasing and construction teams. All of us are focused every single day on lowering cost, reducing cycle time, and achieving even flow of production. Turning next to our land-light strategy, this focus has been the primary driver of cash flow generation over the past several years, leading to the strongest balance sheet in our company’s history. And we have taken it up a notch in the current environment. Quarter after quarter, we have worked with our strategic land banks and land partners where we have established relationships to purchase land on our behalf and deliver just-in-time finish home sites to our homebuilding machine on a quarterly basis. During the fourth quarter, we reassessed every land deal in our pipeline, utilizing updated underwriting. We either restructured the price, the terms, and/or the timing, or we did not proceed with the transaction. The result of this focus was that 75% or approximately $680 million of land purchase in the quarter were just-in-time deliveries from our land banks or land partners. The remaining $220 million of land purchases were made up of option payments and small short-duration land purchases. In fact, about 88% of the land purchased in the first quarter were for transactions under $2 million each. During the quarter, we also terminated contracts totaling about 27,800 home sites. There was approximately $37 million in forfeited land deposits associated with some of these terminations. The ongoing focus on our land-light strategy resulted in ending fiscal 2022 with a controlled home site percentage of 63%, up from 59% last year. Additionally, we reduced the years of owned home sites to 2.5 years at the end of the fourth quarter down from three years last year. Thank you. And I'll now turn it over to Diane.
Diane Bessette, Chief Financial Officer
Thank you, Jon, and good morning, everyone. Stuart, Rick, and Jon have shared a lot about our homebuilding performance, so I won’t add any more details on that. I will, however, discuss our other business segments and our balance sheet, highlight some key points, and then offer some general thoughts for the first quarter of 2023. Starting with Financial Services, in the fourth quarter, our Financial Services team generated operating earnings of $125 million. Mortgage operating earnings were $80 million, up from $77 million the previous year, thanks to a higher level of lock volume as buyers took advantage of attractive rates from our interest rate buydown programs. These discounted rates gave buyers confidence in avoiding possible future increases. Title operating earnings reached $44 million, compared to $30 million last year, primarily due to increased volume and lower costs per transaction as our team worked on improving efficiency through technology. These commendable results came from the effective collaboration between our homebuilding and Financial Services teams as they navigated through this challenging environment. Now, regarding our Lennar Other segment, it reported an operating loss of $106 million in the fourth quarter. This loss was mainly from non-cash mark-to-market losses on our publicly traded technology investments, totaling $96 million. Despite a tough market for tech stocks, we believe there are additional operational efficiencies to be gained through these technology partnerships for both our homebuilding and Financial Services operations, which will enhance the experience for our home buyers. Looking at our balance sheet, as we alluded to, we were very focused on it this quarter. We concentrated on pricing appropriately, turning inventory to generate cash, and preserving cash by aligning our starts with our sales pace. We also revisited every land deal in our pipeline to ensure they met current market conditions. As a result, we ended the quarter with $4.6 billion in cash and no borrowings on our revolving credit facility, providing a total of $7.2 billion in homebuilding liquidity. We continued our progress towards being land-light, ending the quarter with ownership of 166,000 home sites and control of 281,000 home sites, totaling 447,000. This equates to 2.5 years owned, which surpasses our year-end goal of 2.75 years and is an improvement from three years last year. We controlled 63% of our home sites, slightly below our target of 85% due to the termination of about 28,000 home site contracts this quarter. Last year's control percentage was 59%. When we assess our years owned and controlled home sites, we include those with vertical construction as they present lower risk since they can be converted to cash quickly. Moving forward, we will exclude inventory homes from these calculations for better comparison with industry peers. As of November 30, we had around 40,000 homes in inventory, mostly under construction. Excluding these from our calculations, our years owned dropped to 1.9 years, and our controlled home sites increased to 69%. We remain committed to enhancing shareholder returns. Over the fiscal year, we repurchased 11 million shares for $967 million, representing about 4% of our outstanding shares at the start of the year. Additionally, we returned $438 million to shareholders through dividends. Regarding leverage, we made progress by paying down senior notes and generating robust earnings, bringing our homebuilding debt to total capital ratio down to 14.4% at quarter-end, our lowest ever, improving from 18.3% last year. As mentioned, our net debt to total capital ratio at quarter-end was a negative 2.4%. For the future, we have no senior note maturities in fiscal 2023, with our next maturity being $400 million due in December 2023, which pertains to fiscal 2024. To summarize some key points on our balance sheet, our stockholders’ equity rose to $24 billion, our book value per share increased to $83.16, our return on inventory was 32.8%, and our return on equity was 20.9%. The strength of our balance sheet, our strong liquidity, and low leverage give us significant financial flexibility for the upcoming year. As for our outlook for the first quarter of 2023, it’s still challenging to provide our usual targeted guidance given the market uncertainties. Therefore, we are offering broad ranges to outline expectations for various components of the first quarter. We expect new orders for Q1 to be between 12,000 and 13,500 homes, with an ending community count similar to last year due to walking away from deals that would have added new active communities. Anticipated Q1 deliveries will also fall in the range of 12,000 to 13,500 homes, while our average sales price should be around $440,000 to $450,000 as we align with the market. We project gross margins to be approximately 21%, but this could vary based on delivery numbers due to our policy of expensing field costs. As Stuart pointed out, we anticipate Q1 gross margin will be the lowest for the year. We expect SG&A to be roughly 8%, also subject to adjustment based on deliveries and homebuilding revenue. For combined homebuilding joint venture and other categories, we predict a loss of about $10 million. Regarding our other business segments, we estimate Financial Services earnings for Q1 will be between $50 million and $55 million, along with a projected loss of $25 million from our multifamily business and another $25 million from the Lennar Other category. This guidance excludes potential mark-to-market adjustments on our technology investments, which will depend on stock prices at the end of the quarter. We are forecasting our corporate G&A percentage to be about 2.0% to 2.2% due to lower total revenues and our ongoing investment in technology initiatives. We plan to contribute $1,000 per home delivered to our charitable foundation and estimate our tax rate to be around 24.5%. The weighted average share count for the quarter is expected to be approximately 287 million shares. Bringing it all together, this guidance projects an EPS range of about $1.40 to $1.70 per share for the first quarter. Given the market uncertainty, we're only providing a delivery range for the full year of 60,000 to 65,000 homes and are not offering further specifics at this moment. However, we look forward to providing another update during our next earnings call.
Operator, Operator
Our first question comes from Stephen Kim from Evercore ISI. Please go ahead.
Stephen Kim, Analyst
Thank you very much. I appreciate all the information; it's an exciting time here. I found your comment about the outlook for gross margins in the first quarter being the lowest point of the year particularly interesting, and I wanted to delve into that further. You mentioned there are a few components, including lower costs starting to take effect in the second half of the second quarter and into the latter part of the year. Jon, you also indicated that the benefit from lumber is already reflected in the first quarter numbers, so that's likely not a factor. I can see two other reasons why margins might improve: it could be that you are benefiting from a reduction in the levels of specifications or finishes for homes, possibly set to be delivered in the second quarter; or perhaps you've observed an uptick in buyer demand in recent weeks. Could you provide some insight on either of those points? Also, can you let us know the range of mortgage rates you're considering in your outlook?
Jon Jaffe, Co-CEO and President
So, that’s a lot of questions, Steve. So, let me start by saying we do expect that our first-quarter margin, we think, is going to be a low point. I think it derives in large part from a very general notion, and that is we’ve gotten out ahead of the migration downward in pricing. We’ve done it by price reduction and by incentive structure, as noted. And we took a very strong first move in that regard in order to keep the machine, the volume moving in the right direction. With that in mind, we started the reconciliation process with land. Remember, our land position is much shorter term than it’s been in past. And therefore, we have flexibility. And so, we think that we’ll be able to reconcile some land pricing. And as far as our trade partners are concerned, I think I was clear, we’ve been working with trade partners, both on labor and material. Some of those materials like lumber are already filtering through, just at the very early stages filtering through some of the price reductions that will build as we go through the year. But we are working hand in hand with our partners. And given our volume and pickup in market share, there’s a lot of labor, a lot of other people out there that are looking to do business with us. We think we’ll be able to bring our pricing down. Additionally, we’ve been hard at work reconciling efficiencies in the homes that we built, changing products where appropriate and making sure that we are best positioned at sales prices, at interest rates that are higher to be able to access the market and refine our margin as we go through the year. You asked a question as what our assumption is relative to interest rates. We’ve kept a flexibility in our numbers. We recognize that the Fed is focused on unemployment numbers and wage numbers and are likely to continue raising interest rates. But the tenure has had a mind of its own, and mortgage rates have been trending down. I noted the flexibility, the shock absorber nature of our program, our dynamic pricing program that we have in place. All of it is almost agnostic to interest rates. We’re going to keep moving through the year, adjusting our pricing and the affordability for our customers in order to do what we can to maintain volume. So, we don’t have a forward view on interest rates that defines how our program is working, we’re going to be adaptable to the interest rate as it evolves through the year. All indications though are that we’re probably not going to see much more spiking and more moderating relative to interest rates. But that’s a toss-up question.
Rick Beckwitt, Co-CEO and Co-President
I would add that our gross margin is affected by the number of closings we have each quarter. Q1 is likely to be the quarter with the lowest volume. As we close more homes, the fixed overhead costs that are absorbed are distributed over a greater number of closings, which positively impacts our margins.
Jon Jaffe, Co-CEO and President
I just want to clarify, Steve, on what I said about construction costs. As I noted, we're currently working closely with our trade and adjusting contracted pricing. That's what I was referencing in terms of will start flowing through in the second half of the second quarter. The biggest needle mover is lumber, which moved down throughout the year, and we will see a benefit of that throughout the entire second quarter.
Stephen Kim, Analyst
Gotcha. Okay. That is helpful, Jon. So, in other words, you’re not talking about deliveries in the back half of 2Q with that lower contracted pricing. That’s going to be on stuff you’re sort of starting in the back half of 2Q, I guess.
Jon Jaffe, Co-CEO and President
No, starting now and through quarter and even on some open commitments on homes already started. It’s just that we’ll see the first benefits of those renegotiated prices with trade starting to happen in the latter part of the second quarter, and we will see the full benefit throughout the full quarter of lumber reductions that started happening in the summer of '22.
Stephen Kim, Analyst
Okay. That’s helpful. I appreciate that. Second question is on your owned lot count. I know you talked a lot about the ratio in years and all that. But your actual number of owned lots declined for the third straight quarter, and it's down almost 20% from 1Q. And so, I’m wondering, can you help us anticipate how much the actual owned lot count might fall over the next few quarters if market conditions stay challenging and conversely, what kind of market conditions would you need to see for your owned lot count to start rising again?
Diane Bessette, Chief Financial Officer
Yes, I see it positively that our owned home site count is decreasing. Our goal is to protect the balance sheet and reduce risk. Growth really comes from managing what we can and maintaining a lower level of owned home sites. Ideally, the owned home sites should mostly be finished sites where we can start construction soon. Therefore, I’m not concerned about the decrease in owned sites. The aim is to keep that number as low as possible while increasing the percentage of controlled sites.
Rick Beckwitt, Co-CEO and Co-President
Well, and I think that basically, if you think about what we're doing strategically, really building the pipeline between our land bankers, our land bank programming and the execution strategy embedded in our volume-based programming. And that's just going to continue to build confidence. I think that you'll see our owned home site count continue to moderate and be right-sized relative to the business to be able to adequately provide for either stable delivery levels or growth levels as we choose. But that confidence that we're building and that pipeline I think is really value-add for the future.
Stephen Kim, Analyst
Great. Yes, I didn’t mean to imply that I thought that was a bad thing, Diane. I certainly agree with you. It’s a good thing.
Rick Beckwitt, Co-CEO and Co-President
Very good. It’s good, and it’s getting better.
Operator, Operator
Next, we'll go to Susan Maklari from Goldman Sachs. Please go ahead.
Susan Maklari, Analyst
My first question is thinking about the sales pace, would you actually maintain ahead of your historical normal level in the last quarter, despite everything that's going on on the ground. And assuming that that does kind of tie to this broader strategy that you have around inventory controls and cash generation, can you talk to how we should be thinking about the sales pace for next year? The ability to hold it perhaps elevated even as we do continue to move through this environment and what that will mean for the level of cash that you can generate in 2023?
Rick Beckwitt, Co-CEO and Co-President
Looking at our sales pace for the last quarter and our anticipated sales pace moving forward, we plan to continue our momentum. As Stuart mentioned, maintaining an active sales strategy allows us to achieve better leverage from an operational and overhead perspective. Our current pace is higher than it was in 2019, and we aim to sustain that pace as we progress into 2023.
Stuart Miller, Executive Chairman
I think you can expect a lot of consistency. I probably haven't spent enough time talking about our dynamic pricing model, but it is really at the core of how we're running our business, and we're doing it on a day-by-day basis, focusing on how do we get the right pricing for the customer base for today's affordability to maintain that sales pace. I think you're going to continue to see us working hard in that direction. As I noted, it has the ancillary business of informing our land banking pipeline, but the dependability they expected is the dependability they'll get. And we're moving through our pipeline of higher-priced land that was priced or bought to yesterday's pricing, and we'll be bringing in land that is more appropriately priced to current market conditions. All of this kind of works synergistically to really inform us to keep that volume and that sales pace consistent.
Jon Jaffe, Co-CEO and President
I would just add and remind you that our strategy has been and remains matching sales to our start pace, and we have a very steady start pace that will inform our sales pace as we move forward. That ties directly into the dynamic pricing model that, as a tool, our operators use to do exactly that.
Susan Maklari, Analyst
Okay. That’s all very helpful. And I guess it also leads to the next question of how do you think about the uses of that cash. You mentioned that you’re obviously in a net cash position now as it relates to your balance sheet. What are some of the priorities? You bought back stock in this past quarter. Would you consider getting more aggressive there, or anything else that's on your radar?
Stuart Miller, Executive Chairman
I'm glad you asked that question, as it's something many of our investors are considering. We see having cash on hand as an advantage, particularly in challenging times, as it offers us a range of options. Reflecting on this past quarter, it was a difficult time due to declining prices and a complicated supply chain impacted by two hurricanes in our main markets. This was an ideal quarter to concentrate on our balance sheet and cash flow. Moving forward, we expect to continue generating cash through our existing strategies, with stock buybacks being one of our options. We are actively looking at repurchasing our stock and did make some purchases this quarter. However, we decided to proceed cautiously before acting more aggressively. While stock buybacks remain a consideration, we also acknowledge a reduction in production—likely by about a third or more in both multifamily and single-family homes. The existing home market isn't expected to introduce much supply, as buyers are holding onto low interest rates, which will prevent an inventory overflow. Therefore, we believe the duration of this correction will be relatively short. Having additional capital allows us to be strategic in expanding our business when the right signals emerge. Historically, Lennar has been a first mover, and we anticipate doing so again in this situation. We have several viable uses for our cash, including growing the business, repurchasing stock, and paying down debt. We're fortunate to have the flexibility to start slowly and then ramp up our efforts to maximize returns.
Operator, Operator
Next, we’ll go to the line of Ken Zener from KeyBanc. Please go ahead.
Ken Zener, Analyst
Stuart, an iconic movie says, ABC, always be closing, which requires you to start homes to optimize inventory turns, which reduces your land, your most cyclical asset. A simple strategy as many investors overlook when considering margins alone. My first question is, with starts leading orders, could you comment on how you balance the unit economics of, let’s say, the lower margin, 5% versus the incremental cash flow of selling that unit as your land goes down 20% or perhaps 50% when your actual inventory units decline because I think the idea is the income statement is nice, but the cash flow that comes from these choices is much more cyclically important.
Stuart Miller, Executive Chairman
Well, in your question, you basically embedded the entirety of our strategy because the reality is if you look backwards, we have been reducing our SG&A to extremely low levels so that as margins come down, we're still producing cash and we're producing profit and bottom line. But at the same time, it enables us in tougher times to continue turning our inventory, turning our land inventory, as I noted, our higher price purchased to yesterday's pricing land inventory. We will continue turning that. It is cash productive and we'll redeploy that into repriced land purchases for the future. All of this is symbiotic and works to drive cash flows, replenish inventory appropriately positioned while keeping the trains running on time and generating cash flow, improving the balance sheet and maintaining profitability. So, that is basically the game plan.
Ken Zener, Analyst
Great. For my second question, Diane, I noticed your comments about owned land, specifically that it takes 2.5 years compared to 1.9 years without work in progress, which is new information. In that context, if you were to start 12,500 units at an annualized rate of 50,000, does that indicate that your ending inventory units will likely decrease compared to last year’s 60,000? This could lead to a significant cash flow from that reduction in units. Thank you.
Diane Bessette, Chief Financial Officer
Yes, I think that's correct, Ken. As you've heard us say consistently, we're focused on maintaining volume and capturing market share. We're optimistic about addressing some of the supply chain issues. Stuart mentioned that we estimate there might be about $1.5 billion embedded in our balance sheet. While that number can be debated, the key takeaway is that there's a significant amount of cash on our balance sheet. As we move forward, I believe this will result in lower inventory levels and reduced home and construction activity.
Stuart Miller, Executive Chairman
And it brings to mind a meeting we had with one of our investors several years ago, where we outlined our strategy. Do you remember that, Rick?
Rick Beckwitt, Co-CEO and Co-President
Yes.
Stuart Miller, Executive Chairman
We mapped out exactly the strategy and said, this is what we're going to do, all the way down to the reduction in that inventory level, and this is exactly the game plan.
Operator, Operator
Our next question is from Matthew Bouley from Barclays. Please go ahead.
Matthew Bouley, Analyst
I wanted to ask about the potential downside scenarios. Your price taker model is effectively maintaining a strong sales pace and generating cash. You mentioned that the 21% gross margin might be the low point for the year. My question is, if market conditions worsen, how low would you be willing to go on margin? Is there a point where you would stop trading margin for sales? How does your model adapt at these levels of gross margin? Thank you.
Stuart Miller, Executive Chairman
We've been working towards this for a long time, focusing on enhancing efficiencies in our SG&A at the division level, refining and reducing our costs quarter by quarter. If market conditions worsen, we'll maintain our consistent program, as we have room to make adjustments. While there may be some minor impairments if the situation deteriorates, it won't be as significant as in the past. Our operational platform has strong buffers to continue our program, even in a downside scenario, and we will remain focused on growth despite market changes.
Rick Beckwitt, Co-CEO and Co-President
You really can't underestimate the leverage we gain by collaborating with our trade partners as things slow down across the board. People are looking for work. If we're going to be the ones starting homes, we will obtain cost concessions from our trade partners and land partners. We will continue, as Jon mentioned, to value engineer and re-specify products to make them more affordable, allowing us to achieve higher margins.
Matthew Bouley, Analyst
I wanted to ask about the impairment aspect. You mentioned some small write-downs this quarter, and it seems you might expect more modest ones in the future. Given the write-downs this quarter, do you feel like everything has been addressed, or considering possible market downturns, what communities might pose further risks? Could you provide more details on land impairments and any potential option walkaways?
Stuart Miller, Executive Chairman
I understand the concerns regarding impairments that people have. Historically, we have been proactive in addressing these issues. When you ask if we've cleared the decks, I want to emphasize that we are constantly working to manage our situation. If the market continues to decline, we cannot determine the extent of that impact. We will always be transparent and provide as much clarity as we can. Currently, I believe we have accounted for everything necessary in our impairment. Given our cash, balance sheet, and other factors, we thoroughly examined our situation this time, just as we always do, and have addressed any issues. You will consistently see this approach from Lennar; it has always been our practice. Diane, would you like to add anything?
Diane Bessette, Chief Financial Officer
Yes. I was going to say, Matt, if you think about what you’re looking for an impairment, it’s where you’re finding negative net margins. And so if you look at where our gross margins are, it’s not a surprise that our impairment split between backlog and active communities. On the active communities side, it was 8 communities, and we have 1,200. So, there’s always going to be some communities that have negative net margins. But given where we are as a company on average, I don’t think that the concern for net margin should be as great as some people are articulating. There’s always going to be some backlog adjustments. There’s always going to be some communities that are below the norm, but I don’t think we’re anywhere near the widespread impairments that people are voicing concern over.
Operator, Operator
Next, we go to the line of Truman Patterson from Wolfe Research.
Truman Patterson, Analyst
Diane, congratulations on the cash balance. So first question is kind of three-part with your dynamic pricing model. One, could you just elaborate on it a bit more with perhaps not giving away too much competitively, if you will. But second, I understand every market is different, but could you just discuss generally what level of pricing maybe below nearby competing communities is generally needed to move the inventory? And then three, you all, Stuart, I believe, said that incentives kind of accelerated through the quarter, discounts. Any way in orders, you could just kind of give us an understanding where you sat in November, December versus maybe a year ago?
Stuart Miller, Executive Chairman
To be able to understand and really get into the pricing model, you’d have to talk to the inimitable Jeff Moses, and he doesn’t talk to anyone. Keep it internally. But, do you want to go ahead and answer that, Diane?
Diane Bessette, Chief Financial Officer
It’s really an incredible tool, and I’m happy to spend some time discussing it. It’s much more involved than you might think. It requires a home-by-home assessment, considering each home, each community, and each market. The tool analyzes our sales history for that specific plan over time and examines the market competition for that plan in that community. There’s a lot of detail involved, but the key point is that it provides us with an extraordinary amount of real-time detailed information, which is essential for pricing. While we discuss pricing at a high level, it truly operates at a planned community market level. This allows us to be very flexible whether prices are increasing or decreasing. We utilize the tool in all market conditions.
Stuart Miller, Executive Chairman
And it is real-time available to the local market as well as to the corporate office and everyone in between. And so that connected engagement really enables us to stay close to the market, close to the pricing and very interactive at all levels of the company.
Diane Bessette, Chief Financial Officer
And react quickly. Yes.
Jon Jaffe, Co-CEO and President
The other thing that tool does, you hear us throughout our strategies, talk about start pace and sales pace. This tool connects all of the dynamics and metrics Diane just referenced to that pace, so we can adjust in real-time to make sure that we’re not ever getting behind the pace that we want to be at.
Truman Patterson, Analyst
Okay. Perfect. And then any thoughts on how much we might need to adjust in relation to some nearby competitors?
Rick Beckwitt, Co-CEO and Co-President
Well, as we said in the commentary, we're constantly evaluating what's going on with other competitors, what their inventory position is, what their pricing is, are they generating sales? And this is a very fluid conversation that Jon and I have with the regional presidents and the division presidents. We are all over this. And to the extent someone makes a pricing adjustment and if we need to move something, we're going to move it. We want to stay ahead of it and hopefully have them follow what we do. And there's not anything that we're really not familiar with that's going on out there.
Stuart Miller, Executive Chairman
All of this aligns with our digital marketing focus. We have a strong digital marketing team that incorporates data science, which works perfectly with the dynamic pricing program. Therefore, we are building our customer base and developing pricing strategies that will be appealing and meet at a common point.
Rick Beckwitt, Co-CEO and Co-President
And I think that the drop to mic or the proof in the pudding is, and Stuart mentioned that we’ve only got 900 completed homes in the Company right now. And in many ways, I would tell Jon, I’d like some more. Jon said he’d like less. We have our even flow and machine going and homes are being produced as we match them to sales, we’ve got the perfect amount of inventory.
Stuart Miller, Executive Chairman
Yes. And I’m going to say as long as you brought it up, we have 900 homes in inventory. We would actually be better with more of that standing inventory because of today’s customer is premium. And I’d want to emphasize one more time there were no bulk sales at discounted rates to clear inventory. And you don’t always trust what you read. So, let’s go from there.
Truman Patterson, Analyst
Okay. Perfect. And then just on the vendor and contractor savings specifically, what inning of cost savings do you think we’re in today? And as of, we’ll call it, December 15th, are the savings primarily on the labor side, or are there certain materials, products, outside of lumber?
Jon Jaffe, Co-CEO and President
We’re clearly in the early stages of this situation. As the homebuilding industry completes the fourth quarter, all builders are experiencing their busiest production quarter. Although the market has slowed before this quarter, labor has remained active. As previously mentioned, there is typically a delay between the decline in sales prices and construction costs. We believe we are in the beginning of this process and feel that we’ve gained significant momentum. I anticipate noticeable changes as we progress through the first and second quarters due to the dramatic slowdown in new starts within the industry. We have maintained a steady pace for our starts, so as labor becomes more available, it will lead to lower labor costs. Additionally, the reduction in starts will increase the availability of materials for manufacturing, which should also result in lower material prices. However, material costs usually follow labor costs with a longer delay due to their longer production cycles.
Operator, Operator
Our next question is from Alan Ratner from Zelman & Associates. Please go ahead.
Alan Ratner, Analyst
Stuart, I’d love to drill in a little bit on your kind of industry-wide starts outlook for next year. My initial reaction when you kind of threw out down 30% was a little bit of a surprise. And I guess the way I’m thinking about it is, you guys are targeting a pretty flat pace for the year. Your largest competitor D.R. Horton has kind of articulated something similar. You guys are 25% of the single-family production market. There’s been a lot of other builders that pulled back very sharply this year on starts as they were kind of clearing through some of the spec they built up in the spring. But if you have said we see the advantages of spec. We’re going to ramp our start pace heading into the spring to kind of capitalize on that as well. So, I guess, my question is, how do you kind of arrive at that number? And let’s say, for argument’s sake, the decline is less than that, let’s say, 10% or 20%. Does that impact your confidence on kind of getting the cost savings that you’re clearly expecting for the year and the margin guidance that you gave as far as 1Q being the low watermark?
Stuart Miller, Executive Chairman
So first of all, Alan, I’d say that we could look at some of the larger builders, and I’m sure that they’ll adjust their start pace and no one has fleeted the switch in industry, a lot of very smart participants. But there are some practical realities relative to smaller builders across the country. Remember, the larger builders are that we make a proportion. And the capital markets are complicated right now. It’s not just a question of strategy for some. It’s a question of what can you actually get started and how are the capital markets supporting it. I think that it might be only 10% or 20% or 30%. I don’t know what the percentage is going to be. My personal view is that it looks like many of the smaller builders are really pulled back, the complication of price reductions and what’s been paid for land and stuff like that. The other side of it, which makes up about a third of production is multifamily. And the multifamily capital markets are very frozen up right now. I think that the number of new communities coming out of the ground for multifamily and even the single-family for rent buyers are kind of seized up because of capital markets considerations. So, let’s not even throw in strategy just from a capital market standpoint, it feels to me, can’t prove that, a very sizable portion of starts for next year are going to be under limitation. Now, if it ends up being only 10% instead of 25%, still, you’re looking at a housing shortage. I know that there are many with different opinions on this. I believe there’s been a production shortage, housing shortage across the country. If you talk to mayors and governors across the country, their single biggest concern is workforce housing supply and affordability. It is a drumbeat that is in almost every major city and every state. And we feel that there is a shortage that is going to be compounded by the fact that there will be some production and reduction out of this and whether 10% or 35%, it’s still going to be short supply, and I think a more limited downturn.
Alan Ratner, Analyst
I appreciate the insight there, Stuart. Secondly, I think you kind of touched on it a little bit. You highlighted your can rate peaking in October, but just to kind of be more explicit. Can you just talk about what changes you have seen over the last 3, 4 weeks with the pullback in rates? Have you seen home buyer demand improving? And any pricing power coming back even or maybe a moderation in the need for additional incentives thus far in November and early December so far?
Stuart Miller, Executive Chairman
We’ve observed an increase in traffic and higher buyer demand, both in the community and on our website. There are definitely fewer cancellations, which is noteworthy. All of this has contributed to stabilizing the environment, though it hasn’t yet resulted in higher pricing. Typically, these factors come into play before we gain some pricing power.
Stephen Kim, Analyst
Okay. That is helpful. Thank you.
Stuart Miller, Executive Chairman
Thank you, Mike, and thank you, everyone, for joining us. I know that we went on a little longer than normal, but these are complicated times. It’s been a complicated year-end and we wanted to give a lot of detail. Look forward to reporting back in our first quarter. And if you have further questions, give us a call. Thank you, everyone.
Operator, Operator
That concludes today's conference. Thank you all for participating.