9 Ways for Investors to Cash In on Home Improvement
Home is where the ROI is. Return on investment, that is.
Though the U.S. homeownership rate is down to 63.4 percent, the lowest since 1967, and millions of properties have finally regained the value lost in the 2008 recession, Americans never stopped replacing broken windows, hammering on new shingles and installing new appliances. Here's how analysts view the home improvement market and considerations for investing in the castles we call home.
The home improvement market is "cyclical, but not as cyclical as homebuilding itself," says James Goldstein, a senior analyst with New York-based CreditSights, which covers the U.S. retail market. Home improvement retailers saw sales erode up to 7 percent during the recession, but that was nothing near the decimation suffered by homebuilders. The Joint Center for Housing Studies at Harvard University reports that new home construction dropped 75 percent during the recession, while home improvement spending dropped 25 percent from the peak of the cycle to the trough.
"Then it bounced back even stronger from that three-year retraction," Goldstein says.
He and other analysts say that homeowners are gradually edging back to bigger renovation projects. During the recession, whole-house remodeling projects and additions came to a near-standstill. Instead, homeowners made minor upgrades such as installing new countertops, and stayed on top of maintenance and energy-efficient improvements (aided by now-expired tax breaks).
This year, cabinetry and big-ticket items are selling more swiftly at major retailers such as Lowe's (LOW) and Home Depot (HD), analysts say, and that sets the table for steady, consistent growth for those retailers and the companies that make materials and components for home projects.
Rising home equity explains this optimism, says Abbe H. Will, a research analyst with Harvard's Joint Center for Housing Studies. After all, it's worth it to spend a bit extra when your house is gaining value.
But, she adds, the long-term picture is pretty, too. An aging population in an aging housing stock translates to a steady flow of small projects to retrofit houses so that senior citizens can continue to live in them. Though millennials are famously reticent to buy houses, thousands of single-family homes are being rented out by investors, and those institutional owners must ensure that those properties are marketable.
The Joint Center estimates that home remodeling spending increased 7.7 percent in 2014, from 2013, and projects year-over-year growth of 4 percent into early 2015. "We call this healthy, sustainable growth, even strong growth," Will says.
The key indicators are home sales, tracked by the National Association of Realtors and various federal agencies, and the number of houses whose owners owe more than the house is worth, a figure tracked by data firm RealtyTrac. Owners tend to fix up houses before selling, and new owners tend to tackle improvement projects within two years of buying. And, rising values validate improvement beyond maintenance, Will says.
Home improvement is still slow in cities with high proportions of distressed properties, including Las Vegas, Phoenix and parts of Florida, Will says. Conversely, cities with high, stable incomes, that were least hard-hit by foreclosures, are seeing the biggest rebound in renovation. These include Washington, D.C., many northeastern coastal cities and major cities in California.
The obvious beneficiaries of home improvement are retail giants Lowe's and Home Depot, and their major suppliers.
Mary Ellen McGonagle, founder of Santa Monica-based MEM Investment Research, says that Home Depot has the strongest numbers and the highest traffic. "It has double-digit earnings estimates and the numbers continue to be revised upwards," she says.
But the real action is a step back into the retailers' supply chains. American Woodmark Corp. (AMWD), which makes cabinets under its own brand as well as the house brands for Lowe's and Home Depot, is on a roll, McGonagle says, citing LED lighting firm LSI Industries (LYTS) and PGT Inc. (PGTI), which makes windows. "These smaller companies have a niche and earnings numbers," she says.
Once the renovation project is complete, homeowners typically bring in new furniture and accessories, and that spells a cushy future for Restoration Hardware Holdings (RH) and HomeGoods, which is a division of discount retailer T.J. Maxx (TJX).
Funds that include residential real estate plays include two exchange-traded funds -- the iShares U.S. Home Construction ETF (ITB) and the SPDR S&P Homebuilders ETF (XHB). Both concentrate on home builders, home improvement and related categories.
One subcategory that seems impervious to consolidation, and thus to investment, is that of contractors and service providers. The highly fragmented market of small local contractors has endured a shakeout but hasn't attracted discernible interest from investors.
But Home Depot is investing in contractors by buying Interline Brands, a wholesale supplier to remodelers and homebuilders. Goldstein points out that Lowe's also has completed several similar, though smaller, deals. "They have the supply chain to do it, so it makes sense," he says of the retailers' expansion of their wholesale side.
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