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Thursday, September 13, 2012

How To Make Money In Stocks From The Real Estate Rebound

If you are a homeowner and watched the value of your home decline 20% or more, it is only natural to hesitate these days when hearing the words “housing” and “investment” in the same sentence. The dynamics of the real estate market are changing, though, and several homebuilders, home improvement retailers, and construction materials companies have regained much of the value that evaporated since housing prices peaked in 2007.

Following a generational boom, turmoil in real estate market over the last five years torpedoed home prices by as much as 40% in many regions of the U.S., and sank investor confidence along with it. What traditionally had been regarded as a person’s most valuable asset – their home – quickly became an over-leveraged money pit and a financial albatross to many Americans. Trillions of dollars in home equity vanished and as a result, homeowners not wanting to throw good money after bad halted home improvement renovations, including do-it-yourself projects.

While home values are still well below their peak levels from 2007, we are starting to see enough activity on the housing front to signal a sustainable rebound in residential real estate driven principally by the following:

* Changing supply and demand dynamics – We have experienced a prolonged period of declining home prices accompanied by little new home construction. Yet more recently, excess supply has been absorbed in many of the more desirable real estate markets leading to modestly higher demand. According to the National Association of Home Builders, new home sales climbed 22% from July to September.

Make Money In Stocks From The Real Estate pic Amit's Sereno, 2 BHK Flats near Pancard Club
(Photo credit: Ravi Karandeekar)
*Continued favorable interest rate environment – Not only do we expect interest rates to remain low, there is a distinct possibility they could move even lower. Given the weak jobs report released in early September, there is a strong likelihood another round of quantitative easing is imminent and the Federal Reserve could elect to purchase long-term mortgage securities this time around. Such an action would drive historically low interest rates even lower, including the 30-year mortgage rate, furthering reducing the barriers of entry for potential homebuyers.

*Growing sense of urgency – With prices leveling out and even rising in some markets, there has been greater activity on the part of potential homeowners, who are now showing greater interest after years of sitting on the sidelines in hopes that declining values would lead to even greater affordability. The most recent S&P/Case-Shiller Home Price Index (measuring 20 U.S. cities) rose for the first time in two years (by 0.5%). While always optimistic, the National Association of Realtors recently predicted average home prices would rise by 5% this year and another 5% next year. As the evidence grows that a firm basement for property values has been established, and that valuations are more likely to go up than down, those would-be buyers will re-engage in the real estate market, increasing both demand and competition.

Assuming these trends continue (and we expect they will), how can investors participate in the upside potential of a residential real estate rebound? Here are a number of ways:

*Play the building and construction angle by seeking exposure to home improvement retailers and construction materials companies. As the real estate market stabilizes further, homeowners will be less hesitant to fix up their primary residence. Others will finally see the incentive to refurbish investment properties purchased on the lower level of the price spectrum. Whether it’s to make a sale or improve their own long-term surroundings, there is a growing realization that renovations and expansions are once again a prudent investment.

*Take builders and construction head on by purchasing stocks of home developers. This is a more risky approach for investors as these types of companies experienced high levels of volatility during the financial crisis. However, with excess housing supply largely absorbed and housing starts beginning to increase, it’s not a strategy that should be ignored entirely. ETFs like the XHB and ITB make it easy to buy a basket of builders.

*Buy shares in companies or mutual funds situated to take advantage of increased transactions in the housing market. This is a more conservative approach to play the real estate rebound. Title companies are one example of a business model positioned to capitalize on improving real estate conditions and have typically carried with them lower volatility than the stocks of homebuilders.

One asset class to think twice about before investing in is multi-family and residential real estate investment trusts (REITs). Rising apartment rents and high occupancy rates have lifted REIT earnings in recent years. If the budding trends continue, however, many tenants will have a growing incentive to buy instead of rent. If more renters become homeowners, vacancy rates could rise and REIT revenues could fall from current levels.

Here are some specific examples of companies that could take advantage of the positive trends gaining momentum in residential real estate:

Home Depot (NYSE: HD), the leading home improvement retailer, has shown remarkable execution against several key strategies to drive up sales and profit margins in recent quarters. Rising home values should drive sellers to fix up and buyers to renovate the “phantom” number of homes waiting to be put onto the marketplace. The company is taking market share from major competitors Lowes and Sears, and margins are likely to hit new highs in the coming years on modest same store sales growth. Increased housing turnover would drive further profit growth rates and returns.

First American Financial (NYSE: FAF) is a title insurance company that issues policies to cover potential losses associated with property ownership (i.e. unpaid taxes, liens or assessments). With 27 percent share of the market, FAF is in a virtual duopoly with its one major competitor. Increased real estate transactions translate into more title insurance policies. Added revenues can be highly leveraged across fixed expenses, so profit growth has the potential to improve at even higher rates. While lower mortgage rates and increased refinancing has already increased revenues from their low point in 2009, faster rates of growth could drive share prices even higher.

Lennar Corp. (NYSE: LEN ) is the third largest builder of single family attached and detached homes across most of the U.S.. It also engages in real estate development and trading and has an attractive pipeline of land due to opportunistic buying in a distressed housing market. Orders rose 40 percent in the most recent quarter and average sales prices moved up 2 percent to $250,000. The backlog stands 61 percent higher than a year ago. Profit margins are already higher than peers and margin expansion is likely based on decreased incentives and a movement away from speculative home building.

There’s no guarantee, of course, that residential real estate prices will continue to rise from current levels. Additionally, specific conditions can vary significantly from one zip code to another – and certainly from one geographic region to another. Regardless of that uncertainty, however, depressed housing prices and historically low interest rates , have created both an upside opportunity for investors and a silver lining going forward: An entire generation of aspiring homeowners who five years ago appeared largely shutout of an overpriced real estate market, now face an affordable path to home ownership.

Ben Marks is president and chief investment officer of Marks Group Wealth Management, a Minnetonka, Minn.-based independent registered investment advisory with approximately $450 million in assets under management.

Disclosure: Marks Group Wealth Management owns certain of the aforementioned stocks on behalf of their clients.

By Ben Marks

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