By Chris Martin
For the past several years, investors have been fed a steady diet of gloomy news about the U.S. housing market. The S&P 500 homebuilding index plummeted 90% from its zenith in 2005 to its trough in 2008, serving as a prime indicator for the broader market. But now, there are signs that the real estate sector may be starting to turn around - like a strong recovery in the aforementioned S&P index. Although it is still 70% beneath its peak and approximately where it was a decade ago, it still begs the question as to whether housing stocks are poised for a rebound.
Though overall home prices are still struggling to find footing, the market that has seen the greatest improvement thus far is the high-end community housing sector. As a result, large homebuilders are clawing away market share from their small to mid-sized competitors due to strong market capital and better land locations. For instance, PulteGroup (PHM) is available for new opportunities after having divested itself from lower-margin projects. Its Q2 earnings were 11 cents a share, which turned around a year-earlier loss of the same amount. The company also posted a 32% jump in net new orders, and 8% rise in the average selling price, and a 5% hike in closings. Since it remains on track for profitability for FY 2012, Pulte is an attractive equity for investors.
Lennar Corporation (LEN) has already solidified a presence in the high-margin, quality-over-quantity homebuilding market. Lennar posted much higher second-quarter figures, led by net earnings ballooning to $452.7 million from just $13.8 million in Q2 2011.
D.R. Horton (DHI) recorded strong earnings in its fiscal third quarter of 2012 despite the soft housing market, making the stock one of the most attractive offerings in the short-term. "America's Builder" also posted increases in quarterly revenue and closings of 19% and 14%, respectively. DR Horton also pleased investors by declaring a quarterly dividend of 3.75 cents per share.
The potential rebound in the housing sector will affect more than just the stock prices of homebuilders. Related industries like building materials should also be able to bounce back as construction begins to pick back up. Home improvement companies like Masco Corporation (MAS) used the housing slump to initiate cost savings initiatives like closing plants, headcount reductions, and business consolidation, so it has a stronger foundation on which to build as the economy improves in the future. However, Masco's second-quarter earnings and revenue came in below analysts' expectations, so optimistic traders looking for a bargain might want to keep an eye on this stock.
Vulcan Materials (VMC), the nation's largest producer of construction aggregates, took similar measures and will soon reap dividends from them. The company reported higher EBITDA for the second quarter and the first half of 2012, led by strength in its aggregates segment. Though Vulcan gets less than half its income from the residential market, the company's decision to cut overhead costs, initiate a profit enhancement plan, and sell assets still makes it a smart stock to have in an investing portfolio.
Traders who like to look beyond traditional equities markets might also find some attractive buys among real estate investment trusts. According to a trade group, the REIT sector sharply outperformed the S&P 500 (SPY) in year-to-date and quarter-to-date returns through mid-June of this year. Plus, dividend yields on equity REITs average around 3.3%, which is substantially higher than the S&P 500 yield of 1.5% and the ten-year Treasury yield of 1.58%. The strength of the sector is derived from strong capital structures, advancing portfolio operating fundamentals, and its potential hedging value when interest rates and inflation eventually do go up.
However, when it comes to the different types of REITs, it would be wise to remain selective. Investors should do their homework and look for equity REITs with solid balance sheets, business models that focus on diverse operating skill sets, and a capital structure that doesn't rely too much on the capital market itself. A good rule of thumb would be to select equity REITs with AFFO dividend/payout ratios that are under 85%, representing a nice balance of growth potential and protection against unforeseen events.
In conclusion, a rebound in the housing market holds significant potential for holders of housing stocks. But the days of lucrative returns on all real estate-related equities and REITs across the board are probably gone for good. So a cautious approach backed by thorough research and strategic diversification within the sector is warranted going forward.