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Sectors directly affected by housing market recession.
It’s no secret that the housing market has been on the rise for a few years. But now the market has shifted, with interest rates increasing and buyer demand softening. Whether you’re a seasoned investor or just getting started, staying up-to-date on the latest news and trends is crucial. With housing stocks covering all market segments, there are some to push the pause button on and others to consider buying.
Key Takeaways:
Experts anticipate a housing market recession due to various attempts by the federal government to “pump the brakes” on inflation. During 2021 and into early 2022, the housing market was red hot due to several factors, with real estate investment and cheap financing being the main drivers of increasing home prices.
Investors flooded the housing market searching for investment properties that they could turn into both short and long-term rentals. A low-interest-rate environment meant that investors could realize excellent returns on their rental properties. Lenders enabled investors by allowing them to use their existing properties as security for their next purchase. In turn, competition increased significantly for the limited number of homes for sale.
Add to this the shortage of new homes being built because of supply chain issues, and the result is higher prices. It’s classic supply and demand.
The Federal Reserve responded by sharply increasing the benchmark interest rate over a short period. The benchmark interest rate was lifted 225 basis points by June 2022 for a base rate of 2.5%. In turn, the mortgage interest rate reached 5% on average.
The increase in mortgage interest rates immediately impacted affordability for investors and home buyers alike. With reduced rental profitability and an increase in mortgage payments, the average home buyer couldn’t afford a home as easily. Softer demand from buyers as they took stock of the economy led to houses sitting for sale longer than in the recent past. Only in a few markets, however, did housing prices decline.
Indeed, these aren’t the only factors leading to a housing recession, but they’re the biggest ones influencing the decline in housing sales. Federal Reserve Chairman Jerome Powell announced in August 2022 that the Federal Reserve would keep raising interest rates until inflation drops to 2%. Rates may not fall until the end of 2023, potentially keeping the downward pressure on home sales for some time.
The following is a look at housing market stocks worth watching. Always remember that only you can decide the potential of a given stock’s performance and how it fits into your portfolio.
Home builders have to build or risk going out of business. They prefer to buy land for development, then exit once most, or all of the homes are sold. Homebuilder stocks are more vulnerable to downturns in the housing market as a result, as they don’t have significant holdings or engage in housing management that generates recurring revenue.
Some home builders throw caution to the wind and take on more debt, buying property for development to take advantage of potential windfalls from finished home sales. This creates a problem during a housing downturn because the home builder winds up holding onto more debt when home sales diminish. Here are a few home builder stocks to research further.
DR Horton stock hit a high in the summer of 2022 and has been declining ever since, but that doesn’t mean the home builder is in trouble. Instead, DR Horton is looking towards the future and feels that Millennials will move out of urban areas and into the suburbs in search of places to raise their families. The company sees potential for improved profitability after the interest rate hikes play out.
Toll Brothers, founded in 1967, is the fifth largest home builder in the United States. The company facilitates the construction of upper-end housing and commercial properties and arranges financing for both types of properties. It’s ranked at 411 on the Fortune 500 list and has suffered a slight downturn in its stock value while other home builders have seen dramatic losses. The company builds homes in 24 states and has a portfolio of for-rent properties in urban areas across the U.S.
NVR builds different housing types for first-time home buyers, move-ups, and luxury homes. It focuses on building quality homes at all levels. The builder has discipline by not seeking to take on more debt to purchase more property during strong housing markets. This strategy prevents NVR from holding too much debt and being vulnerable to downturns in sales. NVR also has a mortgage division that accounts for about 20% of the company’s income.
Realty companies are engaged in home sales and represent both buyers and sellers. They range from operations in traditional office spaces to online companies that work with independent agents. These stocks can be sensitive to market forces as they rely on having two interested parties buy and sell a home or similar property. When buyers or sellers become scarce, realtors must work harder to make sales.
Redfin relies primarily on its website to attract potential customers to buy and sell their homes. Local agents work with the customer to show or sell a home through the site. The site also lists apartments for rent, offers mortgage financing for buyers, and provides real-time data for recent home sales in a given market. However, even though Redfin’s model is different than traditional real estate firms, it is susceptible to the same issues of lower buyer demand from rising interest rates.
RE/MAX is a traditional realtor with local agents selling homes under its banner. The company has been operating for decades and has demonstrated its staying power. RE/MAX has an advantage over internet-only realtors in the form of local agents who know the area and can provide familiarity with the locality. It’s a stable company that provides a full-service experience for home sales.
Newmark Group, Inc., is a commercial real estate firm that operates worldwide. It provides integrated services for the real estate investor, owner, and occupier. Newmark provides capital for investment sales, property management, loan sales, agency leasing, debt, and structured finance services. The company is forecast to grow, but it doesn’t have good cash flow coverage for its debt.
REITs, or real estate investment trusts, are a type of company that operate income-generating real estate. These include malls, commercial real estate, apartment buildings, hotels, and more. Some REITs have begun to purchase and rent out single-family homes and avoid commercial real estate since that segment has become much more volatile.
Simon Property Group is most well-known for its portfolio of major malls in the United States. It’s the largest owner of malls and has suffered from the loss of foot traffic during the COVID-19 pandemic. However, people are starting to buy items at retail once again. What’s uncertain about the future of Simon’s shopping malls is their ability to compete against e-commerce sites like Amazon. However, most of Simon’s properties are desirable, high-end shopping malls, making them better equipped to handle the competition.
Prologis focuses on operating large warehouses across the country and facilitating the shipment of goods. In June 2022, Prologis merged with Duke Realty Corporation in an all-stock transaction valued at $26 billion. The combined companies now comprise 153 million square feet of operating floor in 19 major logistics areas and have 11 million square feet of development in progress. Prologis is looking toward the future of intermodal real estate by expanding its footprint and planning to be a leader in the warehouse industry.
Realty Income invests in and manages single-tenant, free-standing properties with long-term net leases. It works with commercial clients to occupy the buildings and uses the net-lease strategy to stabilize lease costs. The company features a diverse portfolio of commercial properties, including Napa Valley vineyards, international grocery store properties, and industrial properties, and redevelops standalone commercial properties to improve their value.
Home improvement retailers tend not to follow housing market trends as they rely on selling to people who want to fix or improve things in their homes. Their stock prices rely on housing trends and the cost of raw materials. Home improvement companies supply items that are always in demand by homeowners and contractors alike, regardless of the housing market.
Home Depot offers a variety of seasonal and year-round items aimed at the do-it-yourself market and contractors. It carries gardening plants and supplies, lawn care products, lumber, paint, and tools, at lower to mid-range quality levels. They also offer higher quality products, but these items aren’t as well-stocked as the lower ranges. This strategy encourages higher sales turnover of products, which ultimately increases profitability.
Lowe’s Companies is similar to Home Depot’s offerings and has the same sensitivity to the home DIY and contractor markets. Lowe’s and Home Depot are in direct competition with each other, and there’s little difference between the two apart from store brands.
However, Lowe’s had a lower-than-expected earnings report, which caused the stock to undergo a significant loss in value. Despite this, Lowe’s is well-established and expects sales to stay steady as the home improvement trend continues.
These are just a few of the many stocks to watch in the housing market. Investors can gain exposure to all market areas, from homebuilders to retailers and even REITs. The most important thing for you as an investor is to do your homework and stay current with what is happening in the economy. The Federal Reserve has committed to moving forward with higher interest rates to fight inflation, which can impact the housing market both now and in the future.
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