This article's focus is a new play on the Feds decision last week to leave rates near zero through 2014. My first article chronicled my conversion into a gold bull, and this one will speak about my joining the pro-real-estate camp.
I live in one of the real estate bubble states, and watched as my neighbors swore that they would all become real estate millionaires in just a short period of time. I had friends I went to school with who where making hundreds of thousands of dollars a year selling mortgages to people who couldn't afford them. When I would ask a simple question, such as, "You realize that you are just paying interest on this loan and the balance keeps growing," they would mock my prudence with comments like "You just don't get it" or "To the victor goes the spoils." To say the least, my prudence paid off -- I am still solvent and still live in my home, whereas the others were not so fortunate.
I now see real estate in a different light, mainly as sector that is thoroughly unloved and despised. I have been watching for a catalyst to reignite the market, and with the Fed's commentary I believe we now have one in place. The main driver of home sales is the payment ie mortgage, taxes and PMI if applicable. At current rates below 4% on a 30 year mortgage with 5% down, a home can be had for less than $1,200 per month, on average. (Source: Bestrates.com; figure doesn't include taxes and PMI, which vary by locality).
I believe that these rates will spur strong interest in the lower to middle end of the market, especially for the first time home buyer. The high end market to me will remain challenged due to overhang of inventory (foreclosures) that haven't been flushed out and higher down payment requirements. I will focus my efforts on companies that avoid the high end market.
The easiest way to play this trend is via an ETF that contains the homebuilder stocks, such as S&P Homebuilder ETF (NYSEARCA:XHB). You will notice from the chart below that they have recovered nicely from their October lows and are close to, if not making, new 52 week highs. The trend has been strong and they have been outperforming the S&P since October. I expect further gains until at least the end of the year.
The second way to play this is to buy a company that has significant real estate holdings. The one I would like to focus on is PICO holdings (NASDAQ:PICO). PICO is a holding company that consists of 5 divisions with real estate being the 2nd largest. As of their last earnings announcement, the company controls 847 finished and 5,036 potential lots in Central California and 385 finished and 348 potential lots in the Central Pudget Sound area of Washington State. The company was able to sell some additional lots during that period for a nice profit.
What jumped out at me was the companies reported book value of $22.33 per share. With the low interest rate trend firmly in place now I believe that real estate will begin to rise due to affordability. I am comfortable with the valuations of the other businesses and see the real estate portion as significantly undervalued. I believe that the real estate will be sold off in the coming quarters at much higher prices than what was paid for them, boosting the companies book value and ultimately the share price. I do see higher potential appreciation this way than with buying XHB and will position accordingly. For those that don't share my view but still want to play the real estate turnaround XHB is a great proxy.