For those homeowners lucky enough to have tapped into the housing market in the past two years, it’s been a big wealth creator, as would-be homeowners contended with a frenzy of multiple offers and limited supply. But now that changing dynamics could cool the scorching-hot space, investors keen on playing the real estate boom can look to some more creative areas to invest.
As we head further into 2022, the Federal Reserve has indicated it will continue to hike interest rates multiple times this year, with inflation running rampant, seeing its highest yearly rise in over 40 years this week. Already, that’s sending mortgage rates, which hit rock-bottom lows within the past two years, spiking back up to pre-pandemic levels—making some experts and investors wary.
Those factors pose risks, but the housing market, in particular, is still on a tear: Per Zillow’s projections, home prices are expected to rise some 2% in April, while CoreLogic more modestly predicts prices will have increased by 0.6% on a month-to-month basis from February to March 2022. Prices have soared roughly 19% from January 2021 through this January, and by some measures they’re expected to continue rising, albeit at a slower pace, for the rest of the year.
The way Saira Malik, CIO at Nuveen, sees it, there are a couple of crosscurrents right now for real estate: “The tailwinds are the limited supply of houses and strong demand, because we have a strong consumer with a lot of equity in their home,” she tells Fortune. “The headwinds are higher interest rates, which will eventually have an impact on the housing market.”
That’s why money managers are largely being more selective in their picks to play the real estate sector (for instance, you won’t find any homebuilders stocks on Fortune’s list this quarter). Plus there are also larger trends afoot, started during the pandemic, that some portfolio managers believe are here to stay: With the widespread shift to working from home or in a hybrid capacity, there are “dramatic changes [to] where people are going to be living. We call this secular migration,” Alex Ely, the CIO of U.S. growth equity at Macquarie Asset Management, tells Fortune.
Given the tailwinds still fueling the real estate and housing market—including less obvious areas like wireless communications towers or home improvement—investors have a few ideas of how to capitalize on these trends. Fortune asked portfolio managers how they would play the real estate market now, including how to hedge some of the more concerning trends emerging in a higher rate environment.
The non-homebuilders
With the traditional housing stocks struggling amid rising rates, some portfolio managers are avoiding the area altogether. The number of new homes being built, though rising, is still constrained in 2022, with roughly 1.8 million homes started versus 1.3 million completed as of February, per the Census Bureau and Department of Housing and Urban Development—as supply-chain snafus add to the tight market.
But elsewhere in the real estate space, some money managers see promise in areas like cell towers. Iman Brivanlou, head of TCW High Income Equities and Global REITs, continues to like cell tower REIT American Tower (AMT, $257), a major player in the mobility and big data space. The company owns and operates wireless infrastructure and communications towers. He believes “we’re still kind of mid days when it comes to this particular trend.” American Tower’s business has some stickiness, as “wireless carriers enter long-term leases that include rent escalators…which gives the firm a highly visible and stable revenue stream,” Morningstar analyst Matthew Dolgin wrote in a January note. And Brivanlou says he’s “confident” that in the next few years, bets on the “high quality” tower names are going to pay off—though that doesn’t mean that payout will be “this quarter or next quarter,” he cautions. Trading at roughly 56 times forward earnings, the stock isn’t cheap on a P/E basis. But analysts estimate it can post respectable 13% revenue growth in the fiscal year ending December 2022.
Portfolio managers like Rick Romano, head of the global real estate securities team at PGIM Real Estate, like Rexford (REXR, $75), an industrial REIT that owns “high quality” real estate in California—a notoriously tight market. Romano notes the company owns a “high percentage of last-mile [warehouses],” helping it benefit from e-commerce as well as ongoing supply-chain issues: “Companies now realize that they can’t rely on just-in-time inventory anymore. They need to have redundancies in their distribution system, and that means…more need for industrial space, more demand for last-mile warehouse,” Romano suggests. It comes at a high price based on forward earnings, but Rexford is expected to grow revenue by 35% in the current fiscal year ending in December (though sales could slow to around 20% the following year).
The work-from-home (or anywhere) trend should also continue to boost companies like Airbnb (ABNB, $160), which, as Malik puts it, is a “little less traditional” of a pick. But the company recently beat earnings estimates in its February earnings report, and Malik suggests that Airbnb’s “main driver” is that nights booked should “exceed pre-pandemic levels.” She also points to the trend toward “longer stays (‘living’) rather than ‘traveling,’” which is “reflected in increased room nights booked for one month or longer,” she points out. The tech stock comes at a pretty penny, though, trading at over 120 times forward earnings, though revenues are expected to rise by about 30% in the current fiscal year ending in December.
Home-improvement picks
As Macquarie’s Ely put it, “Yes, higher mortgage rates and tough compares may slow new builds, but strong home-improvement trends continue.”
And for investors not wishing to bet big on housing supply finally catching up, portfolio managers like Malik believe stocks tied to home improvement have some ongoing benefits in this market. She likes that they tend “to be more defensive because it’s based on existing homes, not only new homes,” and that, as homes age, it “increases the amount of remodeling that’ll go on.” She adds that the amount of equity people have in their homes gives them “the ability to spend and do what they want…to their houses.”
So it’s no surprise that Malik favors Home Depot (HD, $306) and Lowe’s (LOW, $204). Of the two, she prefers Lowe’s, which trades more cheaply (at roughly 15 times forward earnings, versus Home Depot’s 19). She believes Lowe’s can grow earnings at a “double-digit rate on flat comps due to margin expansion, cost controls, and share repurchases,” she noted. With Lowe’s stock down a little over 20% so far this year, Malik argues that risks over it reaching “peak earnings” are “reasonably priced in.” Both companies, Malik argues, should have some pricing power amid the inflationary environment. However, she warns that if consumers start shifting more of their spending away from goods to services, that could be a headwind for both Home Depot and Lowe’s if people are spending more on things like travel rather than fixing up their homes.
In light of the challenges homebuilders are still facing, Macquarie’s Ely prefers stocks that are “not as levered to that homebuilding market.” One he favors is Trex (TREX, $63), a top producer of faux wood used for things like decks. The company also released some new “higher-end products,” as Ely puts it, and he says Trex has been able to “pass through price increases” to consumers. Right now, Trex trades at about 25 times forward earnings, and the Street thinks it can grow sales by roughly 15% this fiscal year.
Ely also likes landscape supply company SiteOne (SITE, $148). Whether you bought a new home or are building one, “that means sod and dirt and rock and trees and gravel and all that kind of stuff,” notes Ely. A key part of its business model is to buy up landscape supply companies, which helps SiteOne leverage the business to “offer products at a lower price point,” he suggests. Trading at around 28 times forward earnings, the stock isn’t wildly expensive, and analysts expect it can grow sales by about 11% in the current fiscal year ending December 2022.
Both SiteOne and Trex are down at least roughly 40% since the start of the year, due in part to higher mortgage rates, Ely suggests—but which could also pose an entry point.
The hedging bets
Though housing is still booming, affordability has become an increasingly frustrating problem for would-be homeowners for whom real estate seems out of reach. And if the forces at play do negatively hit the housing market, investors can still “seek shelter” in certain areas of the real estate sector, as PGIM’s Romano puts it.
“Even if you’re priced out of the housing market, you’re gonna have to live somewhere. So you’re going to rent an apartment,” he says. Though higher rents and housing prices, like inflation broadly, are a strain on pocketbooks, “demand for areas like apartments is really robust right now: There’s a real shortage of mid-level and affordable priced housing across the board,” and that demand “creates pricing power.”
That should benefit rental stocks like Equity Residential (EQR, $90), which owns apartments in urban areas like San Francisco and New York. In the inflationary environment that 2022 clearly is, Romano says they want to own companies “that have pricing power,” and Equity Residential fits the bill. The company has also “shifted more to virtual leasing” starting in the pandemic, Romano notes (the company said it’s moved 97% of its tours to self-guided or virtual, per its February earnings call). Equity Residential’s executive vice president and COO Michael Manelis also noted on the February earnings call that “occupancy remains above 97% [and] rates continue to improve.” The Street expects the REIT to grow revenue by nearly 11% in its fiscal year ending December 2022, though at current levels, it’s trading at a hefty 80 forward price/earnings ratio, having recently touched all-time highs. But it comes with a nearly 3% dividend yield.
Nuveen’s Malik also favors Equity Residential, as well as Avalon Bay (AVB, $246), another residential rental company. Like Equity Residential, Malik suggests Avalon Bay has “shown tremendous rental rate pricing power and net operating income growth as we emerge from the pandemic,” noting both are “also strong inflation hedges as leases reset every year.” And of the two, Avalon Bay trades more cheaply, at around 62 times forward earnings.
Self-storage, meanwhile, is an area that could offer the “most revenue growth and the least expense pressure due to inflation,” argues Romano. There he favors CubeSmart (CUBE, $54), which offers monthly leases and has “high occupancy with good pricing power,” Romano says. Self-storage companies are benefiting from the ongoing work-from-home environment, suggests Romano, since people may need to put stuff in storage in order to make room for a home office. He adds the self-storage space broadly also has “low labor costs relative to other sectors.” Still, the stock is off only about 6% from its recent all-time high in December, and trades at almost 50 on a forward price/earnings basis. But analysts expect it to grow revenue by roughly 22% for the fiscal year ending December 2022.
Proving you don’t have to own a house to capitalize on the real estate market.
All stock prices calculated as of April 12, 2022.
