Key Points
The United States economy has seen unexpected growth in GDP this quarter but the real estate market is struggling to keep pace.
This situation has created an opportunity for investors to find potential targets within the housing sector.
Despite the current challenges, there is potential for upside in this “crisis.”
The United States GDP reported a quarterly growth rate of 5.2% in the past quarter, exceeding economist expectations and surprising the market.
However, home sales have reached their lowest level in thirteen years despite the overall economic growth. This indicates potential implications that will become apparent shortly. For now, it suggests that stocks like Pulte Group NYSE: PHM, D.R. Horton NYSE: DHI, and Equity Residential NYSE: EQR may experience significant movement.
Current landscape
A substantial number of homeowners made their purchases when interest rates were extremely low, resulting in an average mortgage rate below 3.0%. With interest rates on the rise, reaching as high as 8.0%, these homeowners have little incentive to sell. Given the continuous appreciation of home prices, selling would mean giving up a mortgage with a rate as low as 3.0% for one as high as 8.0%. Consequently, there is no imminent influx of sellers into the market.
Furthermore, according to the FED, home prices have risen from an average of $503 thousand in the second quarter of 2023 to a higher average of $513.4 thousand in the third quarter. This is a significant increase compared to an average of approximately $375 thousand in 2019.
While some argue that these high average prices make homes and rents unaffordable for the average person, current market conditions may yield different outcomes.
With limited sellers and soaring prices and rates deterring buyers, the market is at a standstill. Consequently, builders like Pulte and D.R. Horton see little reason to continue construction, assuming there would be no demand to absorb the supply. However, this assumption is flawed.
Time for action
Warren Buffett’s decision to invest in homebuilder stocks was driven by the same question: how can prices be lowered to stimulate the market when there are no sellers or buyers? The answer lies in increasing the housing supply.
Investors can position themselves to benefit from the underperformance of the Vanguard Real Estate ETF NYSEARCA: VNQ, which indicates an expectation of declining home prices.
In addition to focusing on builders, analysts at Equity Residential have set a price target of $65.7 per share, reflecting a potential upside of 16.1% for the stock. Furthermore, with a P/E ratio of 15.0x, the stock offers a dividend yield of 4.7%, outperforming inflation and treasury bonds.
Despite the upward trajectory of home prices, REITs like Equity Residential have not yet caught up, prompting them to offer attractive dividends to attract more investors and drive the stock price closer to fair value.
Moreover, Builders FirstSource NYSE: BLDR has experienced a remarkable 106.4% increase in its stock price this year, indicating potential for the construction sector to thrive amidst this positive performance.
In conclusion, whether investors choose to follow Warren Buffett’s lead in investing in builders, diversify with ETFs, directly expose themselves to residential property, or tap into the demand for building materials, there are opportunities backed by various strategic angles.
