More Bets on a Housing Recovery

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bloomberg.com recently ran an article about how private equity and hedge funds are betting on housing by buying distressed mortgage debt from the government. This, on top of aggressive moves to buy distressed homes directly from banks, could be a sign that a housing turn is on its way. In fact, just a few weeks back, Jonathan Gray, global head of real estate for Blackstone Group (NYSE: BX), noted in a Bloomberg interview that he thinks that there is just a two-year window for investors to get into this market.

Buying distressed mortgages in bulk is a very quick way to gain exposure to the home market. Although far more complicated to deal with than buying a bank-owned home, based on the discounts reported by Bloomberg of up to 75% off of face value, The Blackstones of the world could be taking a worthwhile risk.

Playing The Scenario Game
For example, in the worst-case scenario Blackstone would have to foreclose on a home and, thus, wind up owning it. However, the company is already buying homes directly from banks. Buying the debt directly is merely cutting out the middle man. Of course, it is possible that the homes will have been destroyed by their former owners or just simply neglected. In this case, the property will be all that is left.

A better outcome would be that the homeowner gets to stay in their home by paying their mortgage in a timely fashion. With the discounts that have been given to these well-heeled investors, Blackstone and the others can afford to write down the value of mortgages to a point where the homeowner can again afford the debt. Thus, these collections on non-performing mortgages could be restructured to the point where many become performing mortgages. In the government's hands, that probably wouldn't happen. But in the aggressive hands of private equity and hedge funds, a lot can happen quickly.

A Clearing Market
The new owners of the debt will likely be left with three things: Performing loans that can be bundled and sold (or kept and run off), homes that can be rented or sold, and property that can be sold or the site of a new home. With the old stock that has been holding the market down, there is real potential for a healthy clearing of the home market. A recent surge of hiring in the home building industry adds further support to the argument that we are seeing the beginnings of a turnaround.

How Does An Investor Benefit
Most investors don't have the capital to go in and bid for non-performing mortgage debt or to buy up tracts of homes from banks. However, that doesn't mean investors can't participate. Clearly, buying shares in Blackstone Group would be a way to get some exposure. However this private equity firm is huge and widely diversified. So that may not be the best option.

Home Builders
Fidelity Select Construction and Housing Portfolio (FSHOX) counts Toll Brothers (NYSE: TOL) and  Lennar (NYSE: LEN) among its top holdings. In fact, co-manager Daniel Kelley notes that he believes there's still time to invest in the sector because “Housing cycles tend to be long...” While these companies aren't a direct investment in existing home stock, they are an important part of the housing industry and are likely to see increased sales as the housing market recovers. This will, clearly, be beneficial to the top and bottom lines.

Toll Brothers is positioned at the high-end of the home building market. With higher income consumers faring better through the recent recession and the weak economy since, it appears to be one of the best positioned industry participants. In fact, demand has improved materially for the company this year. While it may be among the first to benefit in a housing turnaround, its efficient operations and high-end niche suggest it will continue to do well throughout the next up cycle.

Lennar targets the opposite side of the wealth spectrum, as it targets value buyers. That said, management worked diligently during the housing debacle to clean up the company's business. What's left is a much healthier company and one that will benefit materially from a rebound. That said, the customers it serves may be a little latter to the game and leave a little earlier than those that Toll targets, but, assuming a recovery is under way, it just means that investors need to keep a closer eye on Lennar's sales metrics.

Lumber Jacks
Another way to invest in the area is to go directly to the companies that supply the homebuilders, such as lumber companies Weyerhaeuser (NYSE: WY) and Plum Creek Timber (NYSE: PCL), the largest timber landowner in the United States.

Weyerhaeuser converted to a REIT in 2010 after going through a material business overhaul. Today, over two-thirds of its business is tied closely, if not directly, to housing. While this focus has been a drag through the recession and slow recovery, it will provide a great deal of leverage when the housing market turns. Weyerhaeuser's timber lands are also among the best positioned in the industry, adding a little extra “oomph” to its upside potential.

Plum Creek, meanwhile, has less compelling investment appeal based on its business, which has recently been benefiting from land sales. While management may be taking advantage of good sales opportunities, a lumber REIT can only sell so much land before it no longer has a lumber business to run. The real appeal to Plum Creek is its size, since investors will undoubtedly flock to the largest player in the industry when the housing market turns. This is a decent option for an investor with a shorter time horizon.

The housing market has been mired in a lengthy downturn. However, there are signs of life starting to show through. More aggressive investors should take note and, perhaps, follow the lead of the big boys.

Yours,


ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of Weyerhaeuser Company. 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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