Earnings Call Transcript - LEN Q2 2022

Operator, Operator

Welcome to Lennar’s Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. 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 Alexandra Lumpkin for the reading of the forward-looking statement.

Alexandra Lumpkin, Executive

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. As 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.

Operator, Operator

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

Stuart Miller, Executive Chairman

Very good. Good morning, everyone, and thank you for joining us. This morning, I'm here in Miami and I'm joined by Jon Jaffe, our Co-CEO and President; Rick Beckwitt, our Co-CEO and President; Diane Bessette, our Chief Financial Officer; David Collins, our Controller and Vice President; and Bruce Gross, CEO of our Lennar Financial Services; and of course, Alex, who you just heard from. As usual, I will give a macro and strategic overview. After my introductory remarks, Rick is going to talk about our markets around the country. Jon will update our land program and supply chain and construction costs. And as usual, Diane will give a detailed financial highlight. And as noted in our press release, give some very limited boundaries to assist in go-forward thinking and modeling. And then of course, we'll answer as many questions as we can; please limit to one question and one follow-up. So let me begin and start by saying that we're very pleased to announce another hard fought and well executed quarterly performance by the associates of Lennar. Throughout our second quarter, we continued to sell homes and still offset higher land, labor, and material costs. Our gross margin as reported was 29.5%, net margin was 23.4%. They continue to drive very strong cash flow and bottom line results, as we continue to refine our business model for durability with a very efficient SG&A of 6.1%, which is a 150 basis point improvement over last year and a record for the third quarter. With this strong performance and cash flow, we have continued to fortify our balance sheet with $1.3 billion of cash, nothing drawn on our revolver and a 17.7% debt-to-total cap rate ratio, as compared to 23.1% last year. Accordingly, we're very well positioned to pay down another $575 million of debt later this year, as it comes due and further strengthen our balance sheet. We also managed our sales price and pace through the second quarter and increased new orders by 4% year-over-year, even though we began to see signs of weakening in the overall market. This weakening has continued into the third quarter. The housing market has cooled as expected in response to the Fed's aggressive and rapid reaction to inflation. The resulting very rapid almost doubling of the 30-year fixed rate mortgage rate in six months has had the desired effect of slowing price appreciation and moderating demand by increasing monthly payment costs and reducing affordability. While the market has cooled, it has clearly not stopped. Demand remains reasonably strong as buyers still have down payments and have attractive credit scores and can qualify. Household formation has continued to rise and although we have adjusted some prices in many markets, those prices remain higher on a year-over-year basis. Buyers are seeking shelter from inflationary pressures as scarce rentals drive rents higher. Supply remains limited across the country and the need for affordable workforce housing continues to be at crisis levels. Clearly, production must catch up to the growing household numbers as production of dwellings over the past decade has lagged prior decades by as many as 5 million homes. Nevertheless, the rapid increase in interest rates together with price appreciation have created at least sticker shock and perhaps a more structural cooling of demand. In a few minutes, Rick is going to give a more detailed overview market by market review that will give a more comprehensive snapshot as to what we have seen to date. Although, these preliminary reflections of market conditions are not as positive as the state of the market, indicators have been building since the Fed's tightening began, and given the Fed's expressed conviction to combat inflation by the definitive statements made recently, it seems that these trends will harden as the Fed continues to tighten until inflation subsides. While we can choose to fight against the trend, the reality is that the market has been changing and we are getting ahead of it by making all necessary adjustments. So what is the playbook going forward? We're going to keep it simple and we're going to adhere to our core strategies. To begin, we are going to sell homes adjusting price to market conditions and maintaining reasonable volume. We have discussed over the past years that we have had a housing shortage across the country. We will continue to build as prices moderate and adjust in order to fill that shortfall and provide much needed workforce housing across markets. As we have noted many times in the past, whether the market is improving or declining, we deploy our dynamic pricing model week by week to price product to current market conditions in order to maximize pricing and margin, while we maintain a carefully limited inventory level. As the market moves, we will continue to be responsive. In sync selling homes, we will continue to leverage our extraordinary management team across the country and improve our cost of doing business. We have seen quarter-over-quarter improvements in our SG&A over the past years and we expect to drive efficiencies through technology and process improvement to offset market adjustments wherever possible. Next, we will continue to focus on cash flow and the bottom line to protect and enhance our extraordinary balance sheet. Our great success over the past years to rise from the successes around careful land management and inventory controls which have driven cash flows enables us to reduce our debt, repurchase shares of stock, and drive shareholder returns. In the second quarter, we repurchased another 4.1 million shares of stock for approximately $320 million and drove our return on equity to 21.4%, a 260 basis point improvement over last year. Finally, we will conclude our long planned spin-off by year-end. As we have continued to refine the three verticals of our spin company, we will spin a mature asset management company into the public markets along with billions of dollars of assets under management that we previously held on Lennar's books. The final spin of our new company, which we will call Quarterra, will trade under the stock symbol Q, and as we have noted before, will be an asset light asset management business that will have a limited balance sheet. By finalizing the spin, we will further reduce Lennar's asset base by another estimated $2.5 billion, which will drive higher returns on our assets and equity base and will not result in a material reduction of either our bottom line or our earnings per share. We're very excited about the future prospects for Quarterra as this will be the second spun company in our history and we have great confidence in the prospects for its future. So let me conclude by saying that while the market might be shifting and adjusting to a new higher interest rate environment, we at Lennar are prepared. We are extremely well positioned financially, organizationally and technologically to thrive and to succeed in this evolving housing market. We recognize that the interest rates are rising and inflation continues to be a legitimate threat. We know that the Fed is determined to curtail inflation and this will take some time, but we also know that we can adjust as the market changes and we will. We also know the difficulties in the supply chain continue to persist and we know that land and labor remain in short supply. And we know that cash flow matters and that a strong balance sheet enables us to operate from a position of strength. As we look to the remainder of 2022, we recognize that there are challenges in the market that we must carefully regard expect that we will meet the challenges and that we will continue to adjust to maximize opportunity and drive Lennar into an ever better future. With that, let me turn over to Rick.

Rick Beckwitt, Co-CEO and President

Thanks, Stuart. As you can tell from Stuart's opening comments, the housing market has been reacting to a significant increase in mortgage rates, increased sales prices, continued inflation and the impact of a declining stock market. These changes accelerated during the quarter with May marking the most pronounced impacts. With this in mind, I would like to focus my comments today on the monthly changes during our quarter, current sales environment in our markets and our strategic and operating focus as a company. During the second quarter, our new sales orders increased 4% from the prior year on flat year-over-year community count. Sales pace per community increased from 4.8 to 5 sales per month. We continue to sell our homes later in the construction cycle to maximize prices and offset potential cost increases. During the quarter, we saw year-over-year increases in new sales orders in each month of the quarter, with a variance of less than 125 sales orders between each monthly total. Our sales incentives on new orders during the second quarter were down 10 basis points year-over-year. However, the percentage did increase sequentially each month during the quarter with May new sales order incentives totaling 1.6% of the gross sales price of the home. While the sales percentage in May marked the high point during the quarter, it was still relatively low from a historical perspective. In fact, sales order incentives in May were slightly lower than the average new sales ordering incentive for the latest 12 months. Our cancellation rate during the quarter totaled 11.8%, which increased sequentially during the quarter, but was significantly below our long-term historical average. We ended the quarter with only approximately 250 completed homes that were installed across our national footprint, putting us in a great position in a soft new sales environment. So far in June, new orders, traffic, sales incentives and cancellations have worsened in many of our markets due to a rapid spike in mortgage rates and headwinds from negative economic headlines. Many markets have also slowed as we've entered a seasonably slower part of the year. I'd now like to give you some color on our markets across the country. They really fall into three categories: one, markets reflecting no and minimal impacts; two, markets reflecting modest impacts; and three, markets reflecting more significant impacts. During the second quarter and so far in June, we had 19 markets continue to perform well. These include our six Florida markets, New Jersey, Maryland, Charlotte, Indianapolis, Chicago, Dallas, Houston, San Antonio, Phoenix, San Diego, Orange County and the Inland Empire. All of these markets are benefiting from extremely low inventory and many are benefiting from the strong local economy, employment growth and in-migration. While these markets have continued to be strong, our sales pace and pricing power has started to flatten or has flattened in each of these markets. To maintain sales momentum, we have offered mortgage buydown programs and normalized market incentives. Our category two markets, which reflect a modest softening in pricing and a slowdown in the markets, includes 10 markets. These included Atlanta, Colorado, Charleston, Myrtle Beach, Nashville, Philadelphia, Virginia, the Bay Area, Reno and Salt Lake City. In each of these markets, traffic had slowed and we've seen an uptick in cancellation rates. While inventory is limited in each of these markets, we had to offer more aggressive financing programs and targeted price reductions to reduce our sales pace to keep our sales pace in line with our production schedule. Selectively reducing the sales price to solve for a mortgage payment that works for our buyers has worked well in these markets. Notwithstanding these price increases, net pricing remains higher than year ago periods. Our category three markets, reflecting more significant market softening and correction, includes seven markets. These include Raleigh, Minnesota, Austin, Los Angeles, the Central Valley, Sacramento and Seattle. I'd like to spend a few minutes discussing these markets and what we're doing strategically from a sales standpoint. Raleigh was an extremely strong market in the second quarter, but softened significantly at the beginning of June. This stems from a combination of higher mortgage rates, steep price increases over the last two years, and some job concerns in Texas. We believe pricing pressure will continue until the market resets, and we've been reducing pricing and offering aggressive mortgage buydown programs. Our pricing adjustments have started to take hold and sales activity has begun to stabilize. On a positive note, cancellation rates have not been a problem, inventory is limited and our net new order pricing is still up on a year-over-year basis. As a result, we have room for any needed future pricing adjustment. The Minnesota market has been very challenging. Buyers have always been conservative in this market and as rates have increased, there has been a strong pushback against current pricing. There is very little in-migration in Minnesota, which makes pricing much more challenging because we have a limited pool of only local buyers. We have reacted with strong price reductions, competitive mortgage programs and we're solving through a mortgage payment that works, which is starting to rebuild sales. Austin has been the most impacted market in Texas, following back-to-back years of 40% plus appreciation and bidding more on available inventory. Higher rates in June and headlines on the stock market decline and the distressed national economy have sidelined many buyers who are waiting for a reset in home values. While inventory is limited, cancellation rates have increased, and we've reduced prices in many communities on a home-by-home basis and have offered extremely competitive mortgage programs. These pricing adjustments are starting to generate increased sales activity. Fundamentally, Austin is positioned for long-term growth with low unemployment, higher apartment occupancy, limited home inventory, and strong projected job growth. Our communities in Los Angeles, the Central Valley and Sacramento have experienced a significant slowdown with traffic dropping off considerably in late May and into June. With the spike in interest rates, buyers in these markets have been extremely credit challenged and cancellation rates have increased. We've adjusted prices, are using financing incentives, and in some cases have included non-leased solar systems as part of our home package to rebuild sales. Net new order prices remain higher than the year-ago period, and completed inventory for the most part has not been a problem. The issue continues to be a reset in pricing to solve for the mortgage payment that works in these markets. This is consistent with what Stuart said in his opening remarks. Seattle was one of the strongest markets in the country over the last few years. The markets saw strong in-migration, solid job growth and sales prices that grew approximately 20% annually in each of the last two years. While market fundamentals remain extremely strong with limited land supply and low inventory, buyers have pushed back for a reset in pricing. The prized and highly sought-after locations around Seattle have seen a significant pullback in sales in May and early June. This pullback is a result of both continued price appreciation in the first quarter, causing concern over home values being overpriced, and stock market corrections, which have had a direct impact on employee stock compensation plans. We've adjusted prices in some communities to Q4 pricing and have seen a sales uptick with this correction, which demonstrates the underlying strength of the market. Once again, in this market, we are at prices still significantly higher than year-ago period. I hope this gives you a better picture of our markets across the country and what we're doing to keep sales activity going. The markets remain very fluid, and we are making strategic decisions and adjustments every day. As we've said in the past, we're going to keep our homebuilding machine dwelling, maintain our start pace and price our homes to market. I'd like to now turn it over to Jon.

Jon Jaffe, Co-CEO and President

Thanks, Rick. This morning, I'll discuss our land position and give an update on the status of the supply chain. I will be brief as I know that sales and interest rates dominate the interest of our investors. We are pleased with the excellent progress we continue to make on our land light strategy, as evidenced by our controlled homesite percentage increasing to 62% at the end of the second quarter from 50% last year. We also continue to make progress by reducing the years of supply of owned homesites to 3.1 years at the end of the second quarter, down from 3.3 years last year. To date, we have worked with our land strategies group, which will become a vertical of Quarterra, to continue to reduce our years of land owned even lower. Using this strategy, we have cycled some $10 billion of land and land development from owned to controlled as we refined the supply of just-in-time home sites to our homebuilding machine. Our extreme focus on the land lighter model saved us a significant amount of cash spent on land acquisitions during the quarter. We ended the quarter as noted with $1.3 billion in cash, no borrowings under $2.6 billion revolver and homebuilding debt to capital at 17.7%. As Stuart noted, we are very well positioned to manage through the changing interest rate environment with our excellent asset land light position and very strong balance sheet as the foundation for that position. Turning to the supply chain and its well-documented challenges for the industry. Our second quarter started presenting some favorable news. There were still intermittent disruptions and an increase in construction costs, but for the first time since the disruptions began, we saw a flattening in cycle time. Over the past four months, cycle time has expanded by only five days, which we believe signals a peak. Additionally, about 25% of our markets experienced cycle time reductions in the second quarter compared to the first quarter. There are still challenges that occur, but we are managing them effectively, evidenced not only by this flattening of cycle time, but also by being above the high end of our guidance for second quarter closings. Our direct construction costs in the second quarter were up 1.6% sequentially and 20% year-over-year, both lower than the comparable increases for the same period in the first quarter and fourth quarter of 2021. Rise in labor costs accounted for all of the increase in the second quarter. Material costs were lower due to the lower priced lumber from starts in the second half of last year. We expect costs will rise again in the back half of 2022 as increases in lumber from back in Q1 will flow through those closings. The current drop in lumber prices that we're experiencing, which would start near the end of our second quarter, will lower the cost of our starts in the second half of this year and related deliveries in the first half of 2023. Thank you, and I'll now turn it over to Diane.

Diane Bessette, CFO

Thank you, Jon, and good morning, everyone. So Stuart, Rick and Jon have provided a great deal of color regarding our homebuilding performance, so therefore, I'm going to spend a few minutes on the results of our other business segments and our balance sheet and then review our thoughts for Q3. So starting with financial services. For the second quarter, our financial services team produced $104 million of operating earnings, slightly above the high end of our guidance. And then, when you look at the details between mortgage and title, mortgage operating earnings were $74 million compared to $92 million in the prior year. As we've indicated for several quarters, and as has been greatly documented in the media, the mortgage market has become extraordinarily competitive for purchase business as refinance volumes have all but halted and resale inventories have declined. As a result, secondary margins have been decreased. This was the primary driver for our lower second quarter earnings. Title operating earnings were $30 million compared to $24 million in the prior year. Title earnings increased primarily as a result of higher premiums driven by an increase in average sales price per transaction. And then turning to our Lennar Other segment. For the second quarter, our Lennar Other segment had an operating loss of $108 million. The loss was primarily the result of non-cash mark-to-market losses on our public company technology investments, which totaled $78 million. The remaining loss was primarily related to other strategic investments in this segment. As we have mentioned before, we are required to mark-to-market many of our technology investments that are publicly traded, and that valuation will fluctuate from quarter to quarter. However, we continue to believe that these technology partnerships provide significant operational efficiencies for both our homebuilding and financial services platform and greatly improve our homebuyers experience. And then turning to the balance sheet. As we've mentioned, we ended the quarter with $1.3 billion of cash and no borrowing on our revolving credit facility for a total of $3.9 billion of homebuilding liquidity. And one note regarding our credit facility, last month, we successfully amended and extended this facility. We now have almost $2.6 billion of commitment, $350 million matures in 2024 and $2.2 billion matures in 2027. We were pleased with the execution, which was greatly enhanced by our investment-grade ratings. During the quarter, as Jon mentioned, we continued to focus on becoming land lighter. As a result, at the end of the quarter, we owned 193,000 homesites and controlled 319,000 homesites for a total of 512,000 homesites. This portfolio of homesites provides us with a strong competitive position for continued market share expansion. Our homesites controlled increased to 62% from 50% in the prior year and our years owned improved to 3.1 years from 3.3 years in the prior year. Land transactions may fluctuate quarter to quarter, but progress is made year-over-year. We are still on track to reach our goal of 2.75 years owned and 65% homesites controlled by year-end. And we remain committed to our focus on increasing shareholder returns. As we mentioned during the quarter, we repurchased 4.1 million shares, totaling $321 million. Additionally, we paid dividends totaling $111 million during the quarter. Our next senior note maturity is $575 million, which is due in November this year, and we have no debt maturities due in fiscal 2023. The result of all these transactions with the homebuilding debt to total capital at 17.7%, which improved from 23.1 in the prior year. And then just a few more points on our balance sheet in return. Our stockholders' equity increased to $22 billion. Our book value per share increased to 72.12%. Our return on inventory was 30.5% and our return on equity was 21.4%. In summary, our balance sheet is strong and positions us well for the future. So with that brief overview, I'd like to turn to our thoughts for Q3. As we mentioned in our press release, it is difficult to provide the more targeted guidance that we typically offer given the uncertainty in market conditions. So alternatively, we thought it would be more appropriate to provide very broad ranges to give some boundaries to each of the components of our third quarter. So starting with new orders, we expect Q3 new orders to be in the range of 16,000 to 18,000 homes. We anticipate our Q3 deliveries to be in the range of 17,000 to 18,500. Our Q3 average sales price should be slightly higher than our Q2 average sales price, which as a reminder was $483,000. We expect gross margins to be in the range of 28.5% to 29.5% and we expect our SG&A to be between 6% and 6.5%. For the combined homebuilding, joint venture, land sale and other categories, we expect a loss of about $10 million. And then, as we anticipate our financial services earnings for Q3 will be in the range of $70 million to $75 million as market competition for purchase business continues to increase. We expect earnings of about $20 million in our multi-family business, and for the Lennar Other category, we expect a loss of about $20 million. This guidance does not include any potential mark-to-market adjustments to our technology investments since those adjustments will be determined by their stock prices at the end of our quarter. We expect our Q3 corporate G&A to be about 1.4% of total revenues. Our charitable foundation contribution will be based on $1,000 per home delivered. We expect our tax rate to be approximately 24% and the weighted average share count for the quarter should be approximately 288 million shares. So when you pull all this together, this guidance should produce an EPS range of approximately $4.55 to $5.45 per share for the third quarter. And then turning to the full year, as we mentioned, we're maintaining our previous deliveries guidance of approximately 68,000 homes for the year. However, at this time, recognizing that market conditions are fluid, we will not be providing updated guidance for the other components of earnings. We do look forward to updating our thoughts for Q4 on our next earnings call. With that, let me turn it back to the operator.

Operator, Operator

Thank you. We will now start the question-and-answer session of today's conference call. Our first question comes from Stephen Kim at Evercore ISI. Please go ahead.

Stephen Kim, Analyst

Yeah. Thanks very much, guys. Exciting times. Appreciated all the color you gave on the call. There were a couple of comments you made about incentives and lumber, and you also gave a range of guidance for 3Q gross margins. And so I was curious, it was a pretty strong 3Q gross margin number. And I was curious, how much of the sequential increase in incentives is envisioned in that guidance? I think you said incentives were running at 1.6% in May, so I'm kind of queuing off of that? And then also how much of a headwind from lumber, because I think Jon mentioned that there was going to be some of that. So in both cases, I'm talking sequentially from what you experienced in 2Q?

Jon Jaffe, Co-CEO and President

Hey Stephen, it's Jon. Regarding incentives, they remain relatively low. As Rick pointed out, we're currently seeing about 1.6% in some markets, which are still adjusting. This might increase a bit. In terms of lumber, what's reflected in our numbers and already in our backlog, which supports our guidance on gross margins, is approximately a $6 increase per square foot compared to the beginning of the year. We have clear visibility on that.

Stuart Miller, Executive Chairman

Right. Let me just add to that Steve, most of what you're seeing flowing through our third quarter is already in backlog. So it's not just lumber that's in backlog, it's also many of the incentives. There will be some cancellations and some rotation through. And so we'll see some movement through the quarter. And as we noted, given the changing environment it’s going to be hard to say what actually the numbers are going to round out to be. There's going to be some averaging. Just remember that on the third quarter, we have a pretty good sense of visibility given the fact that a lot of our backlog is focused on the third quarter.

Stephen Kim, Analyst

That's a valid point. Regarding that, I'm interested in understanding the exposure to cancellations. Most builders, except for you, seem to be providing information about the amount of earnest money deposits they collect from their customers as a percentage of the average selling price. Could you discuss that? Additionally, I'd like to hear about the single-family rental market. When you mentioned your markets, it was noticeable that you didn't emphasize rents, which are an important aspect. I know there's been strong demand for acquiring single-family rental units, but there are concerns about whether that demand will wane in the current climate. Can you elaborate on how your company might benefit from rising rates pushing more business towards the rental market, unlike in previous cycles?

Rick Beckwitt, Co-CEO and President

So first let me address the question on backlog and deposits. One of the things that our mortgage company has done is really attack and lock our Q3 and Q4 backlog. We've had a very concentrated effort to make sure that people have mortgages in place so that when closing comes up, they're good to go.

Jon Jaffe, Co-CEO and President

Just mortgages in place, but interest rates dropped.

Rick Beckwitt, Co-CEO and President

The interest rate dropped.

Jon Jaffe, Co-CEO and President

Yes. And what was the back part of that question, Steve?

Stephen Kim, Analyst

It was referring to the single-family rental appetite for newly built homes.

Stuart Miller, Executive Chairman

So let me say, Steve, that the entire rental market is interesting right now. We've talked a lot over the quarters about housing shortage. The fact is that even as interest rates go up, people still need a place to live; household formation remains strong. I know you've covered a lot of these dynamics. And at the end of the day, we're probably going to push more people from homeownership towards rental that will mean multi-family, traditional multi-family as well as single-family for rent. I think there's going to be some dynamic shifting that moves around in all of these areas to the extent that we move more people out of homeownership and towards rental, it increases the demand for an already supply constrained component of the market, that's the rental market both SFR and traditional rentals. If you look at rental rates and where they have been moving over the past year, both on the traditional rentals and the single-family for rent, you've seen pretty aggressive movements upward in rental rates. That is a function of limited supply and growing demand. So how this is going to play out, as part of what we point to as some of the confusion or some of the question marks that sit out there over the next quarters as the market reconciles to a new interest rate environment, rental rates that are moving and shifting and even the SFR buyers are going to have to rethink what their model looks like. They have higher interest rates in their capital stack, but they also are getting higher rental rates from their customers. So we're going to have to see how that plays out.

Rick Beckwitt, Co-CEO and President

And as I said in my comments, Jon, Stuart and I are making daily adjustments to pricing to make sure that we maintain them and those adjustments incorporate what's going on with rents in the single-family communities and the investment buyer.

Buck Horne, Analyst

Hey. Good morning. Thanks for the time. I wanted to talk a little bit about the pace of starts that you maintained through the second quarter. It's interesting that the starts pace was still well ahead of the absorption pace even as mortgage rates were consistently rising through the quarter. Was that a function of the quality of the traffic you were seeing or that the buyers that you saw coming in the front door in terms of their ability to purchase? Was there some larger thinking in terms of maintaining the starts pace at that elevated run rate?

Stuart Miller, Executive Chairman

We have previously mentioned that our pace of starts primarily relies on an orderly program for building and delivering homes consistently. The pace has faced constraints due to the limited availability of permits and the personnel needed to secure the entitlements and permits essential for starting home construction. Consequently, we anticipate some fluctuations in our starts; particularly as we approach the third quarter, we foresee a slight reduction primarily due to the challenges in obtaining permits. As I have reiterated, we have been observing a limited supply of housing nationwide over the past few years. While the country navigates interest rate adjustments and sales price realignments, we will maintain an orderly start program. Even as demand fluctuates, we will adjust pricing to ensure the right number of deliveries meets the workforce efficiencies present in most major markets.

Rick Beckwitt, Co-CEO and President

And we've said over the past years that we match our sales to our start pace versus the other way around to maintain that orderly discipline that Stuart described. We feel that gives us much better control of our cost inputs and then keeps our machine very efficient.

Stuart Miller, Executive Chairman

The other thing that is behind the numbers is that we've strategically, as we've done in the last several quarters, sold our homes later in the construction cycle, which works very effectively in this market because our buyers want to lock their loan closer to the time that they're going to be closing on the home. As a result, we've limited presales or early sales which makes the start pace a little bit higher than the sales pace.

Buck Horne, Analyst

Got it. Very helpful. Thanks for all that. And following up a little bit on the kind of the way the pricing adjustment process works that you're managing through that. It sounds like as we talk with investors, there's still a lot of concern about potential land impairment risks with falling prices from here. But as you work through this, it sounds like all the pricing that you're still looking at is higher on a year-over-year basis. Are there instances where your pricing adjustments are reducing base prices below what the backlog customers might have already paid?

Stuart Miller, Executive Chairman

It's important to note that we have virtually no risk of land impairment in our backlog. Our margins remain strong. We are aware that prices will fluctuate, and we will continue to find efficiencies in providing value for our customers. Our land acquisition model and program are very solid, and for us to consider impairments again, the market would need to decline significantly. This reminds us of the last financial crisis, which we are not facing now. We have plenty of margin and flexibility in our program before we even have to think about impairments.

Rick Beckwitt, Co-CEO and President

Also very different from last cycle, as mentioned in my comments, our land strategy has been focused on really positioning land on a controlled position and structures that can adjust to a changing market environment, which gives us further insulation from the potential of impairments.

Stuart Miller, Executive Chairman

And the other thing that we've seen with regard to backlog is to the extent in many markets that someone cancels out, we have a replacement buyer because there's such limited available inventory that's ready to close on.

Alan Ratner, Analyst

Hey, guys. Good morning. Thanks for all the detail. Appreciate it. First question, I guess, really helpful kind of bucketing those markets there in terms of ones that you're seeing maybe more of an impact versus others. I'm curious in the bucket with the seven where you, you have been more aggressive on incentivizing and reducing prices. Are you able to quantify what the margin impact from all of those various actions you've taken is on the orders you've placed in June vis-a-vis what maybe deliveries were or orders were earlier in the year? I'm just trying to figure out, you kind of mentioned all the tools you're pulling, but it's hard to tell exactly what the margin impact might be in those various buckets at this point?

Stuart Miller, Executive Chairman

It’s why we've given broad boundaries instead of guidance; we don't want to guess because there are a lot of moving parts, a lot of them. They're the obvious ones like lumber prices and realtor costs and a variety of things that we can put our finger on, but then there's also operating leverage and where ASP is going to go and a variety of things. We know that we're trying to aim for a moving target and that target is moving in ways that we can't always anticipate. So the answer to your question is, we're not quite sure yet. We've tried to give some boundaries as to what we see coming up in the third quarter, and we're going to address the fourth quarter as we get closer to it and see what that landscape looks like, Alan. To get more granular than that would be a series of guesses but I don't think brings any of us closer to something that's actionable.

Alan Ratner, Analyst

Okay. I appreciate that, Stuart. I know it's certainly a moving target here. Second, congrats on the land strategy shift and the execution there getting the option share higher. I guess just from a bigger picture standpoint, when you think about the land market and you think about your land portfolio, your lot count is up about 70% over the last two years and that growth has come entirely through option deals as the own piece has shrunk a bit. Your closings this year are going to be up about 25% over that two-year time period. And you're talking about wanting to maintain the start pace so even if we kind of assume that that’s through this choppier period here, you're able to maintain volume. It doesn't seem to me at least that there's a real reason why you would need 70% more lots under control and recognizing a lot of that is off balance sheet. There's still a fair amount of capital tying up that land, which is on your balance sheet and presumably, when you kind of move forward on deciding whether to take down these deals, you're going to have to make that decision. So how are you thinking about tying up incremental land today? Have you slowed the pace of acquisitions? And does it make sense at this point to maybe walk away from some of those deals if the market at best is maybe more flattish from a volume standpoint for the near term or intermediate term?

Stuart Miller, Executive Chairman

Alan, you know the complexities of the land aspect in homebuilding well. At Lennar, we've dedicated significant time to developing our land strategies to improve our future outlook while minimizing risks to our balance sheet. Over the past six years, we've found a balance in this approach. We're particularly excited about our land strategy within Quarterra, which allows us to secure more land and gain better visibility while maintaining maximum flexibility. If the market shifts significantly, we have the options to reassess or adjust our longer-term plans. Our shorter-term strategies are designed to withstand market fluctuations, allowing us to proceed with those developments. We have categorized our land approach into short, medium, and long-term strategies, creating adaptable programs that enhance visibility and lower balance sheet risks. Our current balance sheet is stronger than ever, and our visibility into land acquisition will positively impact our future.

Mike Rehaut, Analyst

Thanks. Good morning and thanks for taking my questions. I wanted to just circle back also to the bucketing of the different markets and appreciate all that detail, it's extremely helpful. Wanted to get a sense of in the second and third buckets, as a percent of sales perhaps, what have those price adjustments been? And or if you could talk about it perhaps on a net pricing basis inclusive of incentives. And is it fair to just anticipate that those adjustments would flow through into the fourth quarter?

Stuart Miller, Executive Chairman

Well, as I said in my remarks, we're adjusting pricing on a home-by-home basis. And in many of these markets, net pricing and gross pricing is up 40% to 50% over the year-ago period. So it takes relatively modest price adjustments to move the needle in order to spur some activity in these markets. What buyers are really focused on right now is just sticker shock. There's been an increase in mortgage rates, and that combined with the economic headwinds, people just are concerned; are they making the right decision at this point in time? Reality is that the market has very limited inventory. We're seeing rent growth in all of these markets. So folks are really just trying to make sure that they don't feel that as when they talk to their neighbor there is a downward pull. So people are working through the process. They understand that values have adjusted.

Jon Jaffe, Co-CEO and President

Just one point of clarification as Rick mentioned earlier, it involves a mix of mortgage rate systems and forms of buydowns for commitments and adjustable-rate mortgages, along with some price adjustments. The mortgage component is very significant as you manage this. As Stuart pointed out earlier, people are focused on monthly payments. In most of the markets in the last two segments, there isn't much in terms of price adjustments compared to the combination of assistance with mortgage rates and a smaller price adjustment.

Stuart Miller, Executive Chairman

I just want to point out to my partner Rick that the downward pressure was a bit too much. I think the overall situation was somewhat unclear. Go ahead, Mike.

Mike Rehaut, Analyst

Appreciate that. And just for clarity also, some of those mortgage rate either adjustments or areas of health. Just to be sure, I understand that would also flow through the cost of goods sold or impact of gross margin as opposed to the financial services line. Just wanted to make sure we understood that. But my second question is also kind of shifts to the Quarterra spin by the end of the year. And just I guess you said that you would expect $2.5 billion of assets to come off Lennar's balance sheet. If you could give us any sense of what the total amount of either any additional detail around Quarterra itself in terms of total assets under management, and obviously, you have the different businesses, any type of review or update would be helpful there?

Rick Beckwitt, Co-CEO and President

So we're not giving regular updates on Quarterra just yet and I don't want to get locked in that bucket, but I think we've given some boundaries in our past calls as to assets under management relative to Quarterra. I don't want to give you a number right now. I don't have it at my fingertips. But what I did say is an additional $2.5 billion over time, I think Jon highlighted some of the migration of some of our land assets through our land strategies program. But we've really seen quite a lot of assets come off our balance sheet already relative to our Quarterra verticals and the way they have developed over the past couple of years. I think as we move forward, we're going to continue to see our land strategies program really continue to develop and that will benefit Quarterra. It will also benefit Lennar, but the $2.5 billion that I've highlighted is additional to the dollars that have already migrated from the Lennar balance sheet to the Quarterra private equity components.

Stuart Miller, Executive Chairman

And Mike, what was the first part of your second question?

Mike Rehaut, Analyst

Yes, I just want to clarify or follow up on my first question regarding mortgage buydowns or adjustments. Can you explain where that impacts the income statement, whether it's in financial services or regular gross profit?

Stuart Miller, Executive Chairman

Plus the sales line.

Operator, Operator

Thank you. We will now take one more question.

Susan Maklari, Analyst

Good morning. Thank you. My first question is, you commented that you have seen some relative improvement in the supply chains and it feels like we are maybe at or coming off of the peak there. Can you give a bit more color in terms of what you're seeing on that side? And obviously as the demand does shift and moderate a bit, how you're thinking of the further improvement that can come through there?

Rick Beckwitt, Co-CEO and President

Well, relative to the second part of your question, as always, there's a lag between a shift in markets and a shift in what's going through in terms of construction volume as the construction trades and the supply chain build through the backlog that's under construction. Relative to what we're seeing, as I said in my comments, there's still disruptions, but both we and our suppliers are much better positioned today. Everyone has learned a lot over the last two years and are able to respond very quickly to solving problems where at the earlier parts of the pandemic and disruption, it sometimes could take months to solve problems. We are now being resolved in days. And the two areas where there are ongoing shortages really in electrical equipment and in flex duct. But even those, we're in close communication with our trade partners, that supply that they've got all visibility in terms of what our needs are for the coming quarters. It's very close working relationship.

Stuart Miller, Executive Chairman

Right. The resolution of supply chain issues is not so much in the supply chain and has gotten easier. It's that we've figured out and worked hard to manage it better. We have the residual impact of the fact that our cycle time still remains a sticky kind of larger version of itself. So it still takes us longer to produce a home, which is inefficient and a derivative of supply chain management.

Susan Maklari, Analyst

Okay. That's helpful color. My follow-up question is, when you do think about balance sheet and uses of cash in general, you noted that you did buyback some stock in the second quarter. As things do moderate, but you continue to pursue your strategy around land and the spin of Quarterra and all these other efforts that you've been working on. How do you think of uses of cash and especially maybe shareholder returns in a more moderate housing environment?

Stuart Miller, Executive Chairman

Over the past few years, Lennar has experienced significant success, and instead of resting on our achievements, we have concentrated on improving our business model. We have streamlined our operating costs and focused on generating cash. We have developed systems that minimize inventory and limit our land exposure on the balance sheet, allowing us to generate substantial cash flow. Moving forward, we plan to maintain a strong focus on land visibility, which will help us grow our business systematically. We aim to pay down debt and buy back stock when opportunities arise, supported by our capital reserves, even while investing $2.5 billion with Quarterra. This places us in a strong position, as we mentioned in our press release. Being in a position of strength is advantageous during challenging market conditions. I also want to acknowledge that our management team is pleased to have Rick back with us after his recovery from COVID. He took a few days off, but the company continued to operate smoothly. Now we are back to full capacity and look forward to providing updates at the end of the third quarter, hopefully with more clarity. Thank you all.

Operator, Operator

That concludes today's conference. Thank you for participating. You may now disconnect your line, and please enjoy the rest of your day.