How to Play the Real Estate Rebound

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More signs that the real estate market has bottomed out and is on an upward track were evident in two recently released reports:

1) The S&P/Case Shiller index indicated that prices of single-family homes has increased 6% year-over-year at the end of 2012, the best showing in six years. Only one metro area (NYC) out of 20 reported a decrease.

2) The U.S. Commerce Department reported that sales of new homes hit a 4 1/2 year high and jumped 15.6% to a seasonally adjusted 437,000-unit annual rate in January. Sales of existing homes increased about 9%.

There are companies in many diverse industries benefiting from the housing turnaround.

Do-it-yourself

All those new homes will probably need some work done to them.

An announcement by Home Depot (NYSE: HD) that it will initiate a $17 billion stock buyback program and raise its dividend by 34% was probably partly tied to the on-going housing rebound. The company also reported fiscal 4th quarter earnings of $1.02 billion, up from $774 million a year earlier. Revenue increased 14% to $18.2 billion. Home Depot predicts a 2% revenue gain this year and full year earnings growing to about $3.37 per share; but this is relatively conservative guidance according to many analysts.

Home Depot is likely more bullish than it is letting on. Over the last five years its dividend has grown at an average of only 5% per year. And as long as the company doesn't take on more debt to finance the newly announced buybacks, that program should also provide a positive impact in the future.

Home Depot's rival Lowe's (NYSE: LOW) will also benefit from the housing rebound. Earnings growth picked up at the end of last year in spite of flat revenue. Dividend growth has been robust, averaging 18% per year over the past 3 years. Lowe's P/E of 21 is in-line with that of Home Depot's 24 and its historical average.

Mortgages

Companies that invest in debt secured by housing, or mortgage real estate investment trusts (mREITS), should continue to do well.

An increase in home sales (and continued low interest rates, which the Fed said will be in place for another two years at least) can only mean that more mortgages are being initiated. Most mortgages are backed by the full faith of the U.S. government through agencies such as Fannie Mae and Freddie Mac. The mREIT industry invests in those mortgages and will benefit from the growth.

American Capital Mortgage Investment Corp. (NASDAQ: MTGE), which also invests in non-agency and other mortgage debt, is a relatively small player with about $7 billion in assets and a market cap of $1.5 billion, but is in the middle of a growth spurt right now. Last year it reported a 41% "economic return," which included both dividend payments (it yields a hefty 14%) and an increase in book value. With a current P/E of about 3 the stock is reasonably priced right now. The forward P/E is projected to be about 7. Company officials offered positive guidance for continued growth in its last earnings report.

Energy

All those new houses will require energy. Many of them are heated by natural gas or oil.

Revenues and earnings in the midstream space are relatively immune to variations in the actual commodity prices, and depend mainly on the volume of material passing though pipelines, which move energy from the production fields to storage and distribution points. That volume is likely to increase because of the gains in housing. 

Most of the companies in the midstream area are called master limited partnerships (MLP). One of the more successful MLP's today is Kinder Morgan Energy Partners LP (NYSE: KMP). KMP (which operates approximately 46,000 miles of pipeline) reported earnings that have grown at an annual clip of about 15% in spite of flat revenues over the last few years. The company and analysts project continued growth in the low double digits over the next few years. 

So most industries that are tied to the housing market and its projected continued improvement will probably see growth of their own going forward. Picking the best companies within those industries will pay off.


Mathman6577 owns shares of American Capital Mortgage Investment. The Motley Fool recommends Home Depot and Lowe's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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