Markets are hard to time. Take one of the most-watched components of the U.S. economy—housing. It’s been seven years since the sub-prime mortgage crisis caused America’s housing market to crash. Other parts of the economy have rebounded, but residential real estate indicators are still well below their pre-recession levels. There was a lot of chatter two years ago around stocks related to the housing market, some of it justified, but many observers think the best is yet to come.
To put things into perspective, the U.S. is on pace to build 1.2 million new dwellings this year, which is way up from a low of 550,000 in 2009. However, a decade ago there were more than two million housing starts. While construction may never return to its pre-recession peak, the activity today remains below where it was in 2000, when Americans began work on 1.6 million homes.
Andres Carbacho-Burgos, a housing economist at Moody’s Analytics, is confident that starts will return to at least 2000 levels over the next two years. Why? Because wage growth is picking up—he expects incomes to expand by 3% next year, up from 2% this year—and there are a lot of young people who have put off home ownership and are now itching to get out of their parents’ abodes.
Companies tied to housing demand are experiencing solid earnings growth of around 10% a year says Bob Sewell, president and CEO of Bellwether Investment Management of Oakville, Ont. His portfolios have a “fairly sizable exposure” to various parts of the U.S. housing market, including homebuilders, manufacturers, retailers and banks. “It’s about the U.S. consumer,” he says. “More are employed, we’re seeing wage growth, and they can better afford homes and what goes in them.”
Some of these names have been run up in value. Home Depot, for instance, is trading at 23 times forward earnings, up from about 19.5 just a year ago. That is pricey, Sewell acknowledges, but the growth prospects make up for the higher valuation.
Homebuilders, the purest of housing plays, are also trading at higher multiples than the overall market: 1.8 times book value. The sub-sector is actually down from the 2.7 times book it was trading at last year, as more people have started paying attention to these stocks, says Wilson Magee, a portfolio manager with Franklin Templeton Real Asset Advisors. Their earnings should grow in the low double digits going forward.
Keep in mind that not all housing-related stocks are created equal, in part because housing markets are notoriously local. Find out which parts of the U.S. a company is most exposed to. The east and west coasts are seeing strong fundamentals; the Sunbelt and especially Texas, which has been hit hard by falling oil prices, less so, says Elisabeth Troni, a global real estate strategist with Aberdeen Asset Management. Companies with exposure to Boston, New York, Washington and San Francisco should do well, as construction is strong in those locales, she says.
The biggest risk for investors is around the supply of workers, trucks and materials, says Carbacho-Burgos. If there’s not enough skilled labour to go around and construction costs soar, then activity will slow. That’s unlikely, though, in an industry that has a lot of ground to make up.
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