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Dealing with Distress Head On, Lennar Turning a Healthy Profit

Distressed Asset Management, Workouts Prove Fertile Ground for Homebuilder
February 2, 2011
With the housing markets in distress, Miami-based homebuilder Lennar Corp. has proved correct the old adage that when life deals you a bunch of lemons, make lemonade.

Lennar's real estate investment management company focused on distressed real estate asset management and workouts, Rialto Capital, contributed $57.3 million in operating earnings to the company last year. That profit came on revenues of $125.3 million interest income on portfolios of distressed real estate loans acquired from federal financial agencies and the sale of foreclosed on real estate.

So successful has the effort been that the company is expanding the segment.

"During the quarter, we completed the acquisition, at a significant discount, of approximately $740 million of distressed real estate assets from three large financial institutions," Stuart Miller, president and CEO of Lennar reported in the company's fourth quarter earnings. "In the fourth quarter, we also completed the first closing of our Rialto real estate investment fund with initial equity commitments of approximately $300 million (including $75 million committed by us)."

Rialto's initial plunge into distress came a year ago, when it closed on two structured transactions with the Federal Deposit Insurance Corp. (FDIC). It purchased two portfolios of loans with a combined unpaid balance of $3.05 billion. Rialto acquired 40% managing member interests in the limited liability companies created to hold the loans for $243 million. The FDIC retained the remaining 60% equity interest and provided $627 million of non-recourse financing at 0% interest for seven years. The transactions included 5,500 distressed residential and commercial real estate loans from 22 failed banks.

All totaled during 2010, Lennar acquired loans with an unpaid balance of approximately $3.6 billion as well as more than 300 real estate properties that sellers had appraised at more than $200 million.

"In our Rialto segment we purchased large and small portfolios of loans and REO at wholesale prices and then worked through those assets one at a time to resolve at retail payoff," Miller said in the company's earnings conference call. "It's all about making money by managing the process of purchasing wholesale and selling retail; purchasing in bulk, selling one at a time. And admittedly the assets are a little bit more complex but this is where we are experts."

Lennar's homebuilding division also returned operating profits in the fourth quarter and the company as whole now has had three straight quarters of net earnings. However, Miller said, that while the company thinks it can continue making money from homebuilding in 2011, there is no guarantee.

"As we're looking at our performance for 2011, we're not anticipating improvement in the marketplace. We think that we can remain profitable with solid gross margins. That doesn't mean they won't be somewhat challenged, if market conditions remain challenging," Miller said.

Those challenges, though, are good for Rialto, Miller added.

"Let me just say parenthetically that as market positions continue to remain stagnant, this all goes in favor of our Rialto program and affords us even more opportunity to invest in distress and leverage that operation," Miller said. "So we think that we have a balanced and intelligent program that's positioned for profitability even at current levels with a negative bias."

Going forward, Miller told company analysts that the company is seeing increased activity in terms of the availability of distressed bank assets.

"We think that the timing of closing our fund [Rialto Real Estate Fund LP] is particularly opportune," Miller said. "The additional capital to be invested in a distressed market will be welcomed with a good deal flow. We're currently underwriting literally billions of dollars of additional asset purchases, which we've incorporated in a very disciplined program of underwriting and bidding and negotiating for prices that we're comfortable with. We're very comfortable that we'll be able to fill the bucket continuing going forward."

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