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Comment: Ignore warnings about potential real estate bubbles and look at these stocks with bright outlook


Those who know a thing or two about the stock market bubble are ringing alarm bells in the housing sector. That sounds like bad news – the news that ultimately caused the financial crisis.

Take a look at Kerry Killinger, former CEO of Mutual Savings Bank of Washington. His banking was at the core of the 2007-2008 financial crisis. So his recent warning Emerging housing area bubbles will get your attention.

Other housing experts worry that rising mortgage rates will hurt the sector’s growth. If higher rates cause a decline, it will hurt everyone because home building is a big driver in our economy.

Related: These analysts love stocks allow you to enter the hot real estate market

But should we really be scared? I do not think so.

Yes, it is worrying that home prices rose 10% last year, and we can expect similar increases this year. Such a rapid rise in prices could indicate an active bubble. Buyers continue to chase for scarce supply, another warning sign. Bank of America points out that real estate currently sells for an average of just 16 days.

But here are four reasons why this does not herald the problems ahead for the economy or even housing reserves, for that matter.

1. Lenders and borrowers don’t go crazy

Lenders are following much stricter underwriting standards than they were in 2006-2008, said Doug Duncan, chief economist of the Federal National Mortgage Association (FNMA). So the kind of excesses that have created the financial crisis is not in the cards.

2. Mortgage rates are close to historic lows

Homebuyers at Wannabe have no doubts that 30-year fixed mortgage rates have skyrocketed to 3.2% from an average of 2.8% in the fourth quarter of last year. That seems like a big negative for potential buyers. But really, it’s not that bad. After all, this mortgage rate is still far below the 7.3% average since 1982, says Joel Kan, an economist of the Mortgage Banking Association. “I don’t expect this to be a major hurdle for anyone buying a home,” he said.

Adam Ballantyne, a senior analyst at Cambiar Investors, agrees. “Mortgage rates remain near record lows for the past 60 years, more than compensating for increases in home prices and cost of ownership,” said Ballantyne, who tracks the housing sector for Cambiar.

One big risk is that the surge in inflation will make the yield on 10-year treasury bonds higher, causing the mortgage rate to rise. But this is unlikely for a number of reasons, including increase productivity.

Fannie Mae predicts moderate inflation from 1.8% to 2.2% in the second half of this year to the third quarter of 2022.

3. Demand for homes will exceed supply

Duncan, an economist with the Federal National Mortgage Association, predicts home prices will rise 10 percent this year. He cites the following basic supply-demand imbalances:

Supply of existing homes for sale at an all-time low. Newly built and un-built homes levels are always at an all-time high. And the supply of homes under construction or already built and ready for sale is very low.

What explains this?

Boom, for one. Duncan says they don’t scale and leave the house at the pace of previous generations. One reason is that they are healthier, compared to their age. Next, millennials are turning into the highest age for home buying. Third, a robust economy will bring about solid job growth. Combined with a high savings rate, this will support demand. Next, rents are rising again, which makes people consider home ownership.

Ballantyne, at Cambiar Investors, said: “February and March order operations, which started in the spring sales season, still hit a record for decades for larger home builders.”

Survey work confirms that homebuyers do not have to rest. Fannie Mae’s Home Buy Psychology Index, based on a poll of consumers, rose 5.2 points in March to 81.7. The proportion of respondents who said that this is a good time to buy a house increased from 48% to 53%.

4. Internal operation showed no bubbles

There are a lot of in-house sellers by executives and directors at home-building companies, which is typical for the team. But according to my calculations, it’s nowhere near the frenzy seen before the financial crisis, signaling trouble on the road. Consider the three largest home builders by revenue.

At Lennar
WOOL,
+ 2.88%
,
Insiders have sold $ 11.9 million worth of shares annually over the past two quarters. That’s almost half of the $ 21.5 million per year worth they sold in 2005 and 2006, years before the financial crisis started. At Pulte
PHM,
+ 1.44%
,
Annual sales for the past two quarters were only $ 791,000 compared with $ 3.4 million a year in the 2005-2006 period.

At DR Horton
DHI,
+ 3.57%
,
sales have recently surpassed pre-crisis sales 2 to 1. That looks troublesome. But it’s offset by more favorable rates at Lennar and Pulte, and the massive in-house purchases I recently spotted as real estate developer Howard Hughes
HHC,
+ 0.74%

and PennyMac Financial Services
PFSI,
-1.02%
,
a mortgage creator.

House construction stocks for review

Ballantyne, at Cambiar, thinks fitness stocks will outperform the market in 2021, even though most home fitness stocks are at all-time highs. Just don’t expect the increase we’ve seen over the past three quarters. “Most of the easier money has been priced, because much of the income growth is already priced,” he said.

But there could be more margins on these names, as stock valuations are still exceptionally low. Consider, for example, DR Horton, the largest home builder. It is posting some of the biggest income growth in history (43% last year and 50% this year). But its stock trades at a forward P / E of 10.3, close to the bottom of 10-year historic P / E of 8-15, Ballantyne said.

The valuations of homebuilders are also exceptionally low relative to the broader market, he said, despite the solid backdrop for the group. The price hike is in his view: Demand remains exceptionally high; the supply remains exceptionally low; and the affordability is still very good. Homebuilders, he said, are also in good shape because of lower debt levels, record high profit margins and solid cash flow growth.

Bank of America has a “buy” rating on DR Horton, KB Home
KBH,
+ 3.29%

and Forestar Group
FOR,
+ 2.02%

in home construction and real estate development. JP Morgan
JPM,
+ 0.74%

Analyst Michael Rehaut has a “redundant” rating on DR Horton, PulteGroup and MDC Holdings
MDC,
+ 3.12%
.
He predicts these companies will benefit from solid 2021 demand. Keefe, Bruyette & Woods, a division of Stifel, has a “buy” rating on the Toll Brothers
TOLL,
+ 2.92%

and Lennar
WOOL,
+ 2.88%
.

In the home building supply sector, Bank of America has a “buy” rating on Masco
BUT,
+ 2.18%
,
Armstrong World Industries
AWI,
+ 2.16%

and JELD-WEN Holding
JELD,
+ 2.76%
.

Two ‘insider’ plays

I personally support Howard Hughes, because of repeated insider buying – its executives are buying stocks. This real estate developer has been a “brace” since I suggested it in my stock letter, Brush Up on Stocks (see link in my profile, below) at around $ 50 on month 4 2020. I just reiterate the stock in my letter at its current rate, partly due to more internal buyers, and I continue to own the name.

Howard Hughes buys land in high growth areas in Nevada, Maryland and Hawaii. It prepares the land for development and sells it to home builders, community creators. Howard Hughes then built offices, shopping centers and restaurants on nearby land that it retains to serve the community. It was also a reopening play because of its development in the East River Harbor District in Lower Manhattan.

Insiders also really like PennyMac Financial Services, a mortgage startup. Mortgage market growth will cool down by 2021, but it will remain strong by historical standards. Home mortgage sources will increase by 10%, while refinancing funding will decrease. That dynamic is not negative for PennyMac Financial, as it focuses on home mortgage origins instead of refinancing.

Michael Brush is columnist for MarketWatch. At the time of publishing, he owned HHC. Brush recommended HHC, JPM and TOL in its stock news, Inventory markers. Follow him on Twitter @mbrushstocks.

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